Submitted by Jonathan Moore, CPA, Partner, Eric P. Gelb, CPA, Director and Ryan Mullin, Senior Associate
Private equity firms, lenders, lawyers and other interested parties conduct due diligence to kick the tires on a potential transaction or target acquisition. Due diligence means the comprehensive review of a target company’s financial, operational, customers and markets, legal, tax, HR and IT functions prior to the completion of a transaction.
In short, due diligence is the process of getting the answers to these four primary questions:
1.What are we buying?
2.What is the target’s stand-alone value?
3.What are the synergies and the skeletons?
4.What is the walk-away price?
In turn, these primary questions result in related questions. Our guidance follows.
What are we buying?
This question may seem simpler than it appears. In some transactions, the seller will sell the parent company which includes all the subsidiaries. Or, they may carve out certain assets, subsidiaries, product lines or geographies. When it comes to acquiring lower middle market companies, IT due diligence can be one of the most overlooked processes in the pre-close stages. Although many deal professionals are thorough with their financial and legal diligence, often IT matters barely enter the conversation.
Suppose an operating company relies on valuable intellectual property (IP) that it licenses from a separate corporate entity. Often, we see that the IP creators establish a special purpose LLC to own and license the IP. The target company pays license fees that may include a fixed license fee and/or a variable license fee based on a milestone. Before the acquisition, the entity that owns the IP is an affiliate, i.e. a related party. Post-acquisition, the licensor would become a completely independent entity.