An M&A deal that seems too good to be true is most likely not good. It is easily possible to manipulate financial records to make things look better than they are. For example, sellers can manipulate revenue recognition. It may include channel stuffing or recording sales transactions before they reach the completion phase. Similarly, it is also possible to manipulate expenses by deferring them to a future date.
This can actually help increase deal prices but will hurt the buying side in future. In the text to follow, you will explore the potential financial red flags in M&As, what to look for in financial due diligence in mergers and acquisition deals, and the role of m&a data rooms in making due diligence more efficient and transparent.
Financial Red Flags and Manipulations to Watches for in M&A Due Diligence
As mentioned above it is easy to manipulate financial statements in many ways. When evaluating a target company in an M&A deal, it is necessary to compare its financial performance with other similar companies in the industry. This helps ensure that the business is performing at a level expected within the industry.
One key aspect to look for are off-balance-sheet items. They may include unused commitments or letters of credit, which might affect the company’s financial position.
It is also crucial to monitor working capital trends. If working capital is declining, it may be an indication of liquidity problems or poor resource management.
Cookie Jar Accounting and Revenue Quality
Another issue to watch for is cookie jar accounting. It is a situation where a company might manipulate earnings by shifting revenues or expenses between periods to make profits appear smoother than they really are.
Also, when you analyze revenue, focus not just on the total numbers, but also on revenue quality. Find out where the revenue comes from and what are its driving factors.
Things to look for in SaaS companies
If an M&A deal involves SaaS companies, make sure key metrics are reported. They may include:
Monthly recurring revenue
Customer lifetime value, and
Customer acquisition cost
These metrics help assess a SaaS company’s health. Buyers should also assess whether the company can scale effectively and what synergies can be realized after the acquisition.
Claims of High Growth
Be careful if the target company claims high growth. Sometimes, these claims are tied to specific KPIs that could influence the deal price.
That said, a company may claim strong growth in recurring revenue. However, this might be due to low-margin professional services, which may not be aligned with the buyer’s objectives if the goal is to acquire a SaaS business.
How Can Virtual Data Room Streamline Due Diligence Effectively?
A data room or data room M&A is an online data management platform specifically designed to safely share, store and manage sensitive information during M&As. An M&A virtual data room also ensures that everyone involved in the transaction can freely communicate from anywhere at any time. Here is how virtual data rooms make M&A deals more transparent, efficient, and safe.
More Security and Confidentiality
M&A transactions involve sensitive information and this makes security a top requirement. A secure data room due diligence uses strong security measures like encryption, two-factor authentication, and watermarks to ensure that only authorized users can access documents.
These features help prevent unauthorized access and data leaks. Data rooms also offer better access controls and allow administrators to grant specific permissions based on roles.
Efficient Communication and Collaboration
Clear communication and teamwork are essential in M&A deals. Due diligence virtual data room supports collaboration with features like Q&A modules, annotations, and discussion boards, and instant messages. This allows stakeholders to communicate effectively within the platform.
Data room collaboration tools eliminate the need for scattered emails or insecure external communication methods. Virtual data rooms also offer version control to ensure everyone works with the most recent documents. This reduces errors from outdated information and ensures more informed decision-making.
Transparency
Modern-day due diligence data room providers ensure maximum transparency in M&A deals. You can track user activity with audit trails and restricted access which ensures transparency in the transaction. This eventually builds trust and facilitates smoother, more effective negotiations, and eliminates unnecessary conflicts.
Data Analytics and Insights
Virtual data rooms provide data analytics tools that offer valuable insights into how users interact with shared documents. These insights reveal
Which documents are most viewed,
What sections are of interest, and
How long users engage with specific content.
This information helps dealmakers understand buyer priorities and address potential concerns more effectively.
Lower Costs
Using physical documents in M&A transactions can be costly. You have to bear expenses for storage, copies, and security. However, virtual data rooms eliminate these costs by removing the need for physical document handling. Apart from that, it reduces travelling expenses for dealmakers as communication, data verification and data sharing takes place in VDRs.
Due Diligence Data Room Checklist
A data room for M&A due diligence must have the following documents.
Legal: it includes corporate structure, jurisdictions of operation, and a summary of related party transactions over the past 3 years.
Financial: Share audited and unaudited financial statements with details on off-balance sheet items or liabilities.
Intellectual Property: Include agreements for third-party IP usage, as well as any IP infringements.
Commercial: List the top 25 customers, customers lost in the past year, and key sales channel partners for the last 3 years.
Human Resources: Provide all employment agreements, third-party compensation agreements, and relevant confidentiality or non-compete contracts.
Other important documents include tax details, software policies, important IT resources, ongoing litigation, etc.
Summing it up
Virtual data rooms play a vital role in providing a safe environment for M&A deals, ensure real-time collaboration, lowering costs, and giving detailed insights with advanced data analytics.
