Its Financial Due Diligence (QofE) time – Dive Deep While You can

Sharing a quick note on why, as Searchers (future CEO’s) we should look beyond cost when it comes to Quality of Earnings Report

It was that crucial moment in the due diligence phase where I take my client through the report after weeks of excruciating pain of reconciliations and analysis. Usually, we focus on the big-ticket items in the executive summary and chew over potential deal breakers, stuff we've likely hashed out in emails already.

Some CFOs and CEOs at these major companies view due diligence as just ticking boxes often limiting due diligence scope (due to cost/time) while paying millions to their deal broker colleagues.

Not this time, though. Our strategic buyer wanted the full scope of due diligence and even threw in a few extra scope items for good measure. I admit, I tend to go all out with my reports. Driven by my own aspirations to run my own one day, I dive in as if I'm the buyer, my own cash on the line, which always leads to deeper, more commercially savvy analysis.

For this rodeo, the CEO/CFO team opted for an in-person meeting over the usual cross-border conference calls. The day before, I gave my Executive Summary another once-over and felt geared up for the discussion. Following tradition, our Partner kicked things off, touching on the strategic aspects, value opportunities, and our experience with the Target Management (Often buyers want to know if the CFO is a keep or not).

Then, it was my turn to present. In less than 15 minutes, I wrapped up the executive summary presentation. Next up: Q&A. But here's the kicker: the CEO, not the CFO, had a copy of my report drenched in red ink. I was floored – even my Partner doesn't mark up my drafts that much. Meticulously, we went through my 80-page report line by line, literally. I had to shuffle my day's commitments, juggling office bookings as we went.

I remember vividly him humming about some bad debt written off in one of the years.

At the end, curiosity got the better of me, and I asked the CEO why he invested so much time in reviewing and discussing the report. His answer? "Your summary's great for the go/no-go decision and deal structuring, including funding. But I find real value in the report for my Day 1 of running the business." He explained that due diligence is often the only time to ask the hard questions and do the nitty-gritty analysis. Because come Day 1, no one's going to have the time or expertise for that deep a dive. He remarked- “thanks to your thorough work, he felt years ahead in understanding the business”

One area of due diligence that requires deep dive and very useful for Day 1 prem is revenue growth analysis. First, it should be on the up and when not growing it’s a declining business; stability is a myth.

The key is understanding the nuances of that 10% average growth, for example. How much is driven by pricing, volume, new/existing product lines, new/existing customer bases, new markets? When buying a business, it's not enough to say the industry's booming. It is very easy to have a Target that is tanking even as the industry soars, or vice versa. A Yahoo in the Google era!

Take this one client I assisted to buy a honey business (honey is renowned for long shelf life). Before selling, the owners hyped sales, hinting at price hikes and supply issues to their loyal (and familiar customer base).

Come Day 1 for the new owner? Crickets. No orders. Turns out, customers had stocked up for half a year, thinking the end was nigh. The result? Cash flow under the new owner was too weak to service debts in year one. Luckily, the new owner had deep pockets, and the deal wasn't bankrolled with debt. It was a close call.

So, yeah, I've got stories for days, but here's the gist: due diligence is crucial, not just for the initial decision or securing funds. It's about being day-one ready, not stumbling out of the gate looking like a newbie. #QoE #Qualityofearnings