Financial Due Diligence in an Acquisition Process

In the dynamic landscape of mergers and acquisitions, the age-old wisdom of “look before you leap” resonates. With numerous complexities and risks, advisors often play a pivotal role in guiding buyers/sellers through this intricate process. Among crucial components, FDD is vital even more during times of economic uncertainty.

Navigating Uncertainty and Risk. What is Financial Due Diligence (FDD)?

FDD is a thorough analysis of a target company to provide buyers with the insights needed to make informed decisions. It serves multiple critical functions throughout the acquisition process. First it involves assessing the target company’s historical and projected financial performance by analysing its financial statements and cash flows, challenging its business plan, and evaluating quality of earnings, net debt and net assets. This analysis aims to normalise any exceptional transactions and reflect the target’s recurring activities, crucial for valuation and negotiation of the purchase price. FDD also helps identify potential financial risks and red flags, allowing buyers to mitigate them early and avoid investment failure. Moreover, it plays a vital role in validating the strategic rationale behind an acquisition by aligning financial insights with broader objectives, identifying synergies, and ensuring long-term growth and profitability.

Dealmaking in 2024 and onwards and the importance of FDD in the dynamic landscape of today’s volatile market

Over the past three years, dealmaking has experienced fluctuations. High deal volumes in 2021 and early 2022 were driven by strong economic activity and low interest rates. However, a tightening cycle initiated by the FED in 2022, due to high inflation, led to a downturn in dealmaking activity in 2023. Despite lingering economic and geopolitical challenges in 2024, financial markets are showing signs of improvement due to slowing inflation and anticipated interest rate decrease. The available capital and the strategic imperative for many companies to transform business models are expected to boost deal activity from Q3/24 onwards across various sectors.

However it will be a new way of dealmaking from now on!

Dealmakers will face different conditions compared to past years and must adapt accordingly. Although interest rates are expected to decrease, they won’t return to near-zero levels. This higher cost of capital will lower valuations, necessitating dealmakers to generate more value for similar returns. As deal returns come under greater pressure, quality assets will be highly competitive when they enter the market. Preparedness will be crucial, and speed can be a differentiator. However, it’s vital to balance the need for speed with rigor. While moving quickly is essential, it’s equally important to conduct proper due diligence and ensure that all aspects of the transaction are carefully considered. Meticulously conducted FDD offers buyers/sellers a substantial advantage in comprehending key risks to future performance and have control over value levers. Just as marathoners train rigorously for the race day, investors should lay the groundwork with thorough FDD to sprint ahead in their investments.

Contact:

Beril is a Deals partner of PwC with over 20 years of experience in M&A and Transactions: She serves corporate clients, PE firms and other financial sponsors in the context of their acquisitions, mergers, divestitures, restructuring and carve-outs by performing various advisory services. Beril has extensive domestic and cross-border experience and leads diverse cross-functional and cross-country teams during the Deals process.