Danny Malone, Transaction Services Partner at UNW, explores how financial due diligence can go beyond validating the numbers to help buyers negotiate better deal terms, manage risk and make more informed decisions before and after completion.
Agreeing a headline price for an acquisition target is an important milestone in any transaction, but it is rarely the end of the valuation discussion. Most offers are based on restricted information and remain subject to financial, tax, legal, commercial and other forms of due diligence. As more detail becomes available, the buyer must decide not only whether to proceed, but also whether the proposed price and transaction structure properly reflect the risks and opportunities identified.
Financial due diligence should therefore do more than confirm the historical numbers. Used effectively, it can shape the final deal terms, protect the buyer from identified risks and establish priorities for the critical period immediately following completion.
Moving beyond a confirmation exercise
Financial due diligence is sometimes viewed as a process for checking whether the figures presented by the seller are broadly accurate. This is only the starting point and a precursor to where the real value can be added.
The real objective is to understand how the business generates revenue, profit and cash, and whether its historical performance provides a reliable basis for valuation. This includes assessing the quality and sustainability of earnings, the assumptions supporting future growth and the financial resources required to operate the business.
The findings should then be considered against the buyer’s original investment thesis. If the evidence supports the case, the buyer can proceed with greater confidence. If it does not, the buyer may need to reconsider the price or structure, seek additional contractual protections or, ultimately, walk away.
Establishing maintainable earnings
When negotiating headline deal terms, sellers will commonly present an adjusted EBITDA figure, reflecting items such as one-off costs, owner-related expenditure, discontinued operating expenditure lines, legacy initiatives or other items described as non-recurring.
Due diligence should assess each adjustment in its commercial context, including whether it relates to costs required for the business to continue operating at its current level. It may also identify temporary revenue benefits, loss-making contracts, underinvestment in management or infrastructure, or costs that have been capitalised rather than expensed.
Even a modest change in maintainable EBITDA can have a significant effect once the transaction multiple is applied. Buyers therefore need a robust and supportable basis for the earnings figure used to determine enterprise value.
Defining debt and working capital
Headline valuations are often agreed on a cash-free, debt-free basis.
Cash balances and bank borrowings are easy to identify. However, other cash / debt-like items may be less obvious, including customer deposits, deferred income, bonuses, overdue capital expenditure, invoice discounting facilities and hire purchase arrangements.
Early identification matters. If these items are not considered until late in the process, they can create significant friction and delay completion. Effective due diligence should therefore identify and assess these value-adjusting items early, helping to establish a clear and robust negotiating position for the buyer. Increasingly, we are seeing more detailed definitions of cash and debt as part of the Heads of Terms stage.
Working capital is another important consideration. A buyer will normally expect the business to be delivered with sufficient resources to continue trading in the ordinary course.
Practices that temporarily improve cash, such as delaying supplier payments or accelerating customer collections before completion, may leave the buyer funding a shortfall soon afterwards.
Determining the appropriate level as part of due diligence requires consideration of seasonality, growth, new income streams, customer payment patterns, supplier terms, stock requirements, deficiencies in financial reporting and the appropriateness of accounting policies.
Choosing the right deal structure and mechanism
The two primary completion mechanisms are completion accounts and locked box. Even where a mechanism has been agreed in principle, due diligence can help validate whether it remains appropriate.
Completion accounts may be appropriate where the business is changing rapidly or there is uncertainty over debt and working capital (e.g. caused by inadequate financial information).
A locked-box mechanism, meanwhile, fixes the equity value and offers greater price certainty, but places more emphasis on the quality of the locked-box accounts and identifying potential leakage.
Where value depends heavily on future performance, deferred consideration or an earn-out may help bridge different expectations. Other risks might be addressed through specific indemnities, retentions or conditions that must be satisfied before completion.
Turning information into action
The value of financial due diligence should not end when the transaction completes.
The process often identifies weaknesses in reporting, cash management, financial controls and forecasting. It may also highlight customer dependencies, underinvestment or areas where anticipated synergies require further work.
These findings should feed directly into the buyer’s post-acquisition plan, with actions prioritised, responsibilities assigned and progress measured against the original investment case.
A good due diligence report should therefore leave the buyer with more than a shopping list of issues. It should explain why each finding matters, what it means for the deal and how it can be addressed.
Ultimately, it’s about turning financial information into better commercial decisions – before, during and after completion.
How can UNW help?
UNW’s Deal Advisory team has a dedicated Transaction Services capability, providing financial due diligence support to buyers, investors and funders across a wide range of transactions.
We combine technical expertise with hands-on deal experience, helping clients understand the financial performance of a target business, identify potential risks and opportunities, and use those findings to inform negotiations on price, deal structure and contractual protections.
Our focus goes beyond producing a report – we provide practical, commercially focused advice that helps clients make informed decisions, protect value and plan for a successful acquisition.
If you would like more information about the topics discussed in this article, or any other due diligence related matters, please get in touch with dannymalone@unw.co.uk.