An unforgiving market means dealmakers are being more vigilant. ‘It’s a product of the economy,’ says Alistair Mackie, partner at law firm Holman Fenwick Willan. ‘People are expecting the sky to fall on transactions, so due diligence is much more important.’
This has led to some changes. Mo Merali, head of private equity at Grant Thornton, says, ‘In the past two or three years, sadly, we’ve seen a preponderance of vendor due diligence (VDD), which is slightly contradictory. If you’re writing a report about a business and being paid by that business, surely there must be doubts as to the report’s veracity. Thankfully, VDD is much less prevalent now.’
It is not just the balance sheet that is subject to greater scrutiny. According to Merlyn Gregory, manager of diligence services at Calash, all aspects of the business are now being held up to a harsher light.
‘In the past, commercial due diligence was seen as an ancillary service and often had little relevance to whether the deal would go through,’ says Gregory. ‘It’s no longer a matter of conducting a bit of market research; we’re expected to look at everything from operations to strategy, and people are seeing real value in it. It’s not just because times have changed, but because commercial due diligence is now a more established market.’
In essence, the change means that the right questions now get asked: ‘After we uncover an issue, the price is renegotiated, and this is happening several times, so deals are taking longer and longer. As things pick up, I don’t think people will look at the smallest details as much.’
Owing to the increasingly difficult environment, assessing value has become a minefield. Intangible assets, such as human capital and goodwill, have proved particularly difficult to assess. Mackie says: ‘People have had to challenge assumptions about businesses’ goodwill. Forward sales are difficult to predict; you can’t make assumptions about growth any more. Every part of the business is being stress-tested.’
Pension fund investments have also been hard hit. ‘Pension funds have taken a real knock on stock markets,’ says Mackie, and it might be hard to know how much value has dropped if actuarial information has not been updated.
For the international business, foreign currency conversions are also problematic. As sterling continues to fluctuate wildly, businesses with European or American creditors may find themselves owing that much more, and as Mackie points out, ‘British businesses will find everything more expensive, especially in Europe.’
Merali advises businesses to keep it simple: ‘The key focus should be on the cash generation side of the business. It’s all about actual earnings; it’s hard to trust anything else.’
See also: Q&A – due diligence