Look Beyond the Surface of Pre-Acquisition Financial Statements

Mergers and acquisitions were hot last year, and there are no signs the market will cool down in 2019. No matter how exciting an opportunity seems, though, it’s important to perform thorough due diligence with guidance from an experienced accounting professional.

Consider financial history

The target company’s historical financial statements must be reviewed first. Examining past performance will help you understand the nature of the company’s operations and the types of assets it owns — as well as the liabilities it owes.

When reviewing historical results, it’s important to evaluate a full business cycle, including cyclical peaks and troughs. If a seller provides statements only for peak years, you could overvalue the company and pay too much. Instead, look at enough history to get a full picture, then calculate an offer based on how much return the business interest is expected to generate. An accounting experienced in valuations can project expected returns, as well as provide pricing multiples based on real-world comparable transactions.

Evaluating the target’s historical balance sheet also may help you decide whether to structure the deal as a stock purchase (where all assets and liabilities transfer from the seller to the buyer) or as an asset purchase (where the buyer cherry-picks specific assets and liabilities).

Look to the future

Prospective financial statements present management’s expectations for the future. When reviewing these reports, evaluate the underlying assumptions carefully, especially for start-ups and other businesses where prospective financials serve as the primary basis for your offer price.

It’s also important to consider who prepared the prospective financials. If forecasts or projections are prepared by an outside accountant, do the reports follow the AICPA standards? You may have more confidence when reports provided by the seller conform to these standards. Regardless, it’s still a good idea to hire your own expert to perform an independent analysis, because management has an incentive to paint a rosy picture of financial performance.

Dig deeper

A target company’s historical balance sheet tells you about the company’s tangible assets, acquired intangibles and debts. But some liabilities may not appear on the financial statements. An accounting expert can help you identify unrecorded liabilities like these:

  • Pending lawsuits and regulatory audits
  • Warranty and insurance claims
  • Uncollectible accounts receivable
  • Underfunded pensions

You also need to be skeptical of representations the seller makes to seal a deal. Misrepresentations that are found after closing can lead to expensive legal battles. An earnout provision or escrow account can be used to reduce the risk that the deal won’t pan out as the seller claimed it would.

Thorough research can present costly M&A mistakes

Do-it-yourself acquisitions can lead to costly mistakes. In addition to evaluating historical and prospective financial statements, Weaver’s Transaction Advisory Services team can help identify potential hidden liabilities and misrepresentations, as well as prepare independent forecasts and projections. We also can help you determine the optimal offer price and deal terms based on an objective review of the target’s historical, prospective and unreported financial information. Contact us or visit weaver.com to find out more about how Weaver can help you with a potential deal.

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