Due Diligence Fundamentals

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Due Diligence Fundamentals

• November 6, 2011

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Illustrative Transaction Process
PHASE I Strategic Analysis
PHASE II Opportunity Analysis
PHASE III Transaction Development
PHASE IV Negotiations
PHASE V Transition Optimization
NEEDS RISK ASSESSMENT
SELECTION OF TARGET COMPANY
DUE DILIGENCE
INTEGRATION
NEGOTIATION
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Risk and Needs Analysis
Analysis and Identification
Target Selection
Determination of Deal Drivers
Strategic Direction
IDENTIFICATION OF RISKS AND NEEDS
Due Diligence
External Growth Acquisition
Strategic Target

• EBITDA
• Cash Flow
• Market Share
• Facilities
• Human Capital
• Etc.

• COMPETITION
• PRICE PRESSURE
• INNOVATION
• RETURN ON INVESTMENT
• EMPLOYEE TURNOVER

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Effective Due Diligence Focus on Deal Drivers
EBITDA
ETC.
CASH FLOWS
INTELLECTUAL PROPERTY
MARKET SHARE
Deal Drivers
Accounting Policies Capital Expenditure
Outstanding Litigation HR Compliment
Working Capital Seasonality Pro-forma Adjustments
Forecasts Budgets Cash Burn
Quality of Earnings Revenues Operating
margins Stand Alone costs Related
Party Transactions
Balance Sheet Analysis Contingencies
Commitments Contracts and Obligations Employee B
enefit Plans
Due Diligence Focus Areas
Due Diligence Action Plan
Customized Financial Due Diligence Plan
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Due Diligence and Transaction Value
Due Due diligence procedures are focused on
matters that could impact purchase price and
building in appropriate protections for your
purchase agreement.

• Quality of earnings
• Price vs. volume vs. mix changes
• Givebacks and rebates
• Unsupportable platform volumes
• Loss of key customers
• Productivity assumptions
• Effect of foreign exchange fluctuations
• Commodity price exposure
• Tooling gross margin

Revenue and Margin
Purchase Price
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Non- Operating Assets Liabilities
Working Capital Adjustments
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Targets Normalized EBITDA
Multiple
Tax

• Cash flow analysis
• Deferred spending in anticipation of transaction
• Growth versus maintenance categorization
• Misalignment with revenue growth
• Customer tooling

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Maintenance/ Capex Requirements

• Net debt /Insurance due diligence
• Guarantees
• Contingent liabilities
• Financial debt
• Derivatives
• Incomplete restructuring
• Unfunded pension and OPEB
• Environmental remediation
• Inadequate insurance
• Trapped cash
• Redundant assets

• Cash flow analysis
• Normalized working capital investment
• Recovery of AR
• Inventory valuation
• Completeness of AP and accruals

• Tax due diligence
• Income tax obligations
• Available attributes

Enterprise Value

• Quality of earnings/IT Insurance due diligence
• Unrecorded audit adjustments
• GAAP differences
• Fixed vs. variable cost structure
• Non-recurring/non-cash transactions
• Unsupported cost reduction assumptions
• Temporary wage freezes
• Compensation benefits structure

Operating and GA Costs
Acquisition Accounting
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EBITDA

• Equalizes the differing choices in capital
  structure
• E - Earnings
• B - Before
• I Interest
• T - Income Tax
• D Depreciation
• A Amortization
• Adjusted EBITDA
• Attempts to estimate stand alone sustainable
  operating cash flow
• Accounting issues
• One-time items
• Pro-forma adjustments

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Quality of Earnings Impact to Purchase price
Valuation build-up for target
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Prioritized Synergy Value
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Adjusted EBITDA before synergies
Proforma Adjustments
Cash From Operations

• Constant currency
• Plant closures
• Customer attrition
• Shareholder compensation adjustments to market

GAAP Adjustments

• Gain on sale of fixed assets
• Cash pension
• Unusual warranty claims
• Reversal of provision release

Reported EBITDA

• Capitalized costs
• Revenue recognition
• Incomplete expenses accruals

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Non-Operating Assets and Liabilities

• Net debt /Insurance due diligence
• Guarantees
• Contingent liabilities
• Financial debt
• Derivatives
• Incomplete restructuring
• Unfunded pension and OPEB
• Environmental remediation
• Inadequate insurance
• Trapped cash
• Redundant assets

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Tax Issues and Considerations

• Payroll taxes, property taxes, VAT, HST, GST,
  Duties etc. are operating costs
• Impact EBITDA
• Evaluate liabilities
• Directors can have personal liability
• Understand tax attributes
• Operating losses, capital losses, tax basis of
  depreciable assets
• Impact of prior years tax filings (exposures)
• Establish the foundation for tax structuring

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Working Capital

• Valuation of assets and liabilities
• Seasonality of working capital and operating cash
  flows
• Appropriateness of reserves
• Normal level of working capital
• Cash flow impact of realization of assets and
  liabilities
• Commitments and contingencies
• Accounting policy for complex assets and
  liabilities (i.e., derivatives, funded
  obligations, etc.)

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Financial Due DiligenceValue Proposition

• Optimize Pricing
• Understand the targets business and risks
• Alignment of transaction needs
• Find the skeletons
• Refine the deal
• Development of integration plan
• Avoid a bad deal or Make a Good Deal Better!

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Rohit Prajapati, CA, Macc, BA

• Associate Partner, Transaction Advisory Services,
  Transaction Support
• 416-943-2082