What Should I Review in Due Diligence?
There are many aspects that due diligence should focus on including but not limited to billings versus collections, age analysis of receivables, and seasonal cash flow. There are four key considerations when reviewing these and each is instrumental to the success of the deal.
- Cash flow and profitability. These figure heavily into the twelve key contributors to valuing a practice. The time and timing of a deal must be matched against practice revenue streams. If they do not match up well, adjustments to practice payments or the manner in which practice payments are determined should be addressed.
- Loyalty of the client base. Loyalty of the client base is potentially a double-edged sword. The longer the client has been a client the greater the existing loyalty. Contrary to popular believe, loyalties can be readily transferred but only with the proper transition and announcement strategy. As counter intuitive as it sounds, the greater the loyalty the higher the retention rate should be if a proper transition plan is executed.
- Seller's billing rates. Billing rates constitute one of the great mysteries of accounting and tax work. Many think that a deal won't work because billing rates are different. Deals with different billing rates at the partner level can be challenging. However, more often than not the work does not necessarily need to be done all at the partner level. If this is the case, it could produce potentially more profit than generated by the seller. The buyer's focus should be on determining the time, effort and level of staff that will be needed to complete the work, and the subsequent billing rate and client fees, as compared to the seller's current capabilities.
- Workpapers. The buyer in any deal must review the seller's workpapers in order to:
- Learn what services have previously been provided, what new services can be added, and if a significant amount of time needs to be invested in order to improve the records.
- Estimate the time, effort, and staff needed to complete unfinished work and confirm profitability.
- Reviewing potential liability and malpractice issues.
- Confirm that the seller is not taking unacceptable accounting or tax risks.
- Profitability. The buyer should review the seller's profitability, but the focus should be on the likely profitability after the acquisition is complete. The seller's profit should be a starting point, not an end in itself. Due diligence should focus on both revenues and expenses. An acquisition that enables the buyer to take over a practice with little incremental increase in overhead can be tremendously profitable.
- Equipment and software. What, if any, of the seller's equipment and software is being purchased in the deal? What condition are they in? What does the buyer need to handle new clients? Are there any leases or liens in this equipment?
- Staff. What staff does the seller have? What is the role of the staff in the firm, and how much contact do they have with the clients? Do they have employment agreements that include non-compete language; is it assignable? If some of the seller's employees are part of the acquisition, the buyer should examine compensation and benefits, as well as the staff's strengths and weaknesses. How does all this compare with the buyer's staff?
- Services provided and not provided. The buyer should have the skills, technology, licenses, and time to handle the services currently provided to the seller's clients. In a business environment of growing niche services, the buyer should determine what services the seller does not provide currently but the buyer could profitably add after the acquisition.
- Office facilities. The seller's clients and staff are generally accustomed to their current location. If the buyer is not taking over the lease, adequate space to house the practice and keep clients comfortable will have to be provided. If the buyer is taking over the space, a due diligence review of the current lease should be performed.
- Stability of the client base. Are the seller's clients, especially the larger ones, in good financial shape? Are some of them aging and thus likely to be lost to sales, relocations, or retirements?
- Technology. Does the firm being acquired have current technology? How and what will it take from a technology perspective to integrate the firms?
- Culture. How are they the same and how are they different and what do the differences mean?
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