Financial Due Diligence & M&A Support

A diligence that produces a document and changes nothing has failed, however thorough it was. There are only three useful outcomes, and the report is written to reach one of them.

Walk away from something that cannot be fixed or priced. Reprice, where the finding is quantifiable. Or paper around it, where the risk is real but can be allocated by an indemnity, an escrow or a condition precedent.

Everything in the sections below is directed at one of those three. A finding that does not reach the agreement did not need to be found.

We have been doing this for thirty-seven years, which mostly means knowing where to look first. The trial balance is the beginning of the exercise and not the substance of it.

You are buying the history as well as the business. The review establishes what the numbers are before anybody argues about what they are worth.

• Three to five years, audited against management accounts: Where the two diverge is more informative than either on its own. Revenue and margin by product, customer and geography, and whether the trend is the business or the accounting.
• Customer and supplier concentration: What proportion of revenue sits with the top five customers, on what contracts, with what notice periods, and whether any of them is connected to the seller.
• Related party transactions: Pricing, documentation and whether the business survives their withdrawal. A margin maintained by a related party supply at a favourable price is not a margin the buyer acquires.
• Receivables and inventory: Ageing, the provision against it and the recoverability of what is outstanding beyond a year; inventory existence, condition and obsolescence rather than its ledger value.
• Off-balance-sheet and contingent items: Guarantees given, litigation pending, commitments entered into, employee benefit obligations not funded, and anything disclosed only in a note.

Reported profit is a conclusion. Quality of earnings asks what of it is repeatable in the buyer's hands, which is the only part worth a multiple.

• Normalising EBITDA: Removing one-off gains and costs, proprietor-related expenses that will not continue, related party pricing adjusted to arm's length, and accounting policy differences restated to the buyer's basis. Each adjustment is agreed or it is argued, so each is evidenced.
• Revenue recognition: Whether revenue has been accelerated into the review period, whether cut-off at each period end holds, and whether contract terms support recognition when it was taken.
• Provisions and estimates: Where judgement sits — bad debts, warranty, inventory, capitalised costs — and whether the judgement has moved during the period a sale was contemplated.
• The cash conversion test: Earnings that do not become cash over a reasonable period are a question rather than an answer, and the answer is usually in working capital.

The headline price is rarely the money that changes hands. The working capital mechanism and the debt-like list between them move more value, late in a deal, than almost anything else.

• Setting the peg: A normal level of working capital for the business, derived from a monthly series long enough to show the seasonality rather than from a single balance sheet date. A peg set on a convenient month is a transfer of value disguised as an adjustment.
• Definitions, in writing: What is included, how it is measured, and on what accounting basis the completion accounts will be drawn. Most working capital disputes are definitional, and they are settled before signature or expensively afterwards.
• Debt-like items: Unpaid statutory dues, unfunded gratuity and leave encashment, deferred or disputed tax, customer advances that will be serviced rather than repaid, capex committed but unpaid, declared but unpaid dividends, and lease obligations. Each of these is a claim on the business that the buyer will fund.
• Cash that is not free: Balances restricted against guarantees or margin, and cash that must stay in the business to run it.

This is where our litigation practice earns its place in a diligence. An exposure is only useful once it is quantified and its probability assessed, and that assessment is made by people who argue these matters.

• Direct tax: Open assessments, appeals pending and at which forum, demands outstanding and what has been stayed, and the positions taken in the returns that have not yet been examined. Section 68 and section 69A exposure on share capital, premium and unsecured loans is the recurring one in a closely held company — and the onus, as our notes on these additions set out, is on the company rather than on the officer.
• Indirect tax: Input credit claimed against what the portal supports, mismatch intimations in DRC-01B and DRC-01C and how they were answered, classification and rate positions, reverse charge, and the annual return reconciliations.
• Withholding tax: Deduction, deposit and return defaults, and section 40(a) disallowance that follows them. Payments to non-residents without a certificate are a frequent and quantifiable finding.
• Micro and small enterprise dues: The ageing, the MSME Form 1 filings, and the section 43B(h) disallowance on anything paid outside the time allowed — a liability sitting in the payables ledger rather than in a tax file.
• Employment and statutory: Provident fund and ESI on the correct wage base, contractor compliance, and gratuity funding.
• Corporate and exchange control: ROC filings, significant beneficial ownership declarations, charges registered and satisfied, and the FEMA filings behind every past foreign investment.

A seller is in the strongest position on the day before the buyer's team arrives. Everything after that is defence.

• Finding it first: The same exercise, run against your own business, so that what is found is corrected or explained on your timetable rather than discovered on theirs. A problem the seller presents is a disclosure; the same problem the buyer finds is a price reduction.
• The data room: Organised, complete and consistent, with the statutory records, filings and reconciliations already in it. Delay in a transaction is read as concealment whether or not it is.
• Preparing the disclosure letter: What is disclosed against the warranties is what the buyer cannot later claim on. Drafting it early, from the diligence findings, is the cheapest protection available to a seller.
• Being able to answer: The questions are predictable. Having the answer and the supporting paper ready shortens a deal, and a shorter deal is one less likely to be renegotiated.

A diligence pays for itself in the drafting, not in the report. We stay in the transaction through this stage rather than delivering and withdrawing.

• Warranties and the disclosure letter: Which findings are warranted against, and what the disclosure letter carves out of them.
• Specific indemnities: For an identified exposure — a pending assessment, a known statutory default — with its own cap, its own time limit and its own conduct-of-claim provision. A general warranty does not cover a risk both parties already know about.
• Escrow and retention: How much, held for how long, and released against what. Sized to the quantified exposures rather than to a convention.
• Completion accounts: Preparing or reviewing them, and running the working capital and net debt adjustment against the definitions agreed.
• After completion: Aligning the chart of accounts and reporting cycles, transferring the tax, GST and ROC positions to the new ownership, and carrying the identified exposures into a schedule somebody is actually responsible for.