By Mike French, CPA, Managing Director
After a six-month hiatus as a result of COVID-19, it appears that mergers and acquisitions (M&As) are back on the rise. Potential buyers are moving cautiously, as they should be, as COVID-19 has changed the landscape, adding more risk than before.
Unfortunately, the world of M&As can be ruthless. Sellers are looking to get the most out of their business, which can sometimes turn into false statements and misrepresentation of the facts. It’s important for buyers to get to know the seller, analyze statements on financial performance and asset condition, and test for common fraud schemes.
Whose Side Are They On?
Without adequate M&A due diligence, unwary buyers could fall victim to false representations by sellers that never pan out after the deal closes. Or they may inherit a hornet’s nest of white collar crime and embezzlement by employees.
Even if a company has internal controls in place, owners and executives can override them. These individuals have access to financial statements, and may have incentives — such as to receive bonuses for exceeding certain growth targets — to falsify them.
So it’s essential to perform background checks on your acquisition target’s owners and C-suite executives. A thorough check can uncover past involvement in criminal embezzlement, theft, forgery and other types of fraud, as well as involvement in civil litigation. It could also reveal falsified items on their résumés and other pertinent personal claims.
How “Creative” is the Business?
Financial statements should also be scoured for misstatements. Some owners may use “creative” accounting techniques to artificially inflate a company’s value. They might, for example:
- Pre-book revenues
- Leave stale receivables on the books
- Record phantom inventory
- Defer expense recognition
- Lend money to major customers so they can make large purchases that will inflate sales numbers
Owners might also hide liabilities, falsify transactions with related parties, overvalue receivables and securities, and overstate inventories to boost the selling price.
Tip of the Iceberg
Unfortunately, this is just the tip of the iceberg when it comes to fraud schemes that could diminish the value of your acquisition. In addition to performing financial and legal due diligence, be sure to tour your target’s facilities and interview management for insight into the company’s culture.
If you have questions, want help conducting due diligence or need investigation into possible M&A fraud, PKF Advisory can help. For more information, contact:
Mike French, CPA