Upstream: Transactional Due Diligence: Financial & Tax Due Diligence Procedures

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Upstream: Transactional Due Diligence: Financial & Tax Due Diligence Procedures

A leading private equity-backed group in the technology and engineering solutions sector (“the Company”) was evaluating the potential acquisition of a privately held industrial instrument and electrical contractor (“the Target”) to expand their footprint on the U.S. Gulf Coast. The Company engaged Opportune professionals to perform financial and tax due diligence procedures, including:

  • Identifying non-recurring transactions, timing and cut-off issues, and non-cash transactions to evaluate the appropriateness of reported EBITDA.
  • Analysis of historical revenues, gross margin, G&A, and EBITDA to understand historical trends and drivers.
  • Cash-related procedures, including a comparison of monthly cash deposits and disbursements to reported revenue and expenses and comparison of operating cash flows to EBITDA over time.
  • Evaluation of historical working capital fluctuations and seasonal trends.
  • Analysis of accounts payable and other liabilities, accounts receivable, adequacy of the allowance for doubtful accounts, and associated risks.
  • Understanding the planned transaction structure and tax implications and consideration of any federal, state, employee-related, or compensation-related tax exposures, along with estimating the likely income tax result of a combination of the Target with existing Buyer activity.
  • Understanding trends in growth versus maintenance capital expenditure over time.
  • Understanding future cash commitments to fund obligations and identification of potential off-balance-sheet risks.

Opportune added value by leveraging its Transactional Due Diligence team to provide the Company with a detailed report documenting our work results. Some examples of areas where Opportune added value on this project included:

  • The Target applied percentage completion accounting for its fixed-price contracts (for both financial reporting and income tax purposes) and the continual revision of cost estimates led to large month-to-month fluctuations in both revenue and gross margin on individual projects that were distorting historical performance. Opportune performed a hindsight analysis that took the final project gross margin and applied it to the historical period, which smoothed revenues and gross margin, therefore normalizing revenue and gross margin over the historical period.
  • Opportune identified areas for improvement related to estimating percentage complete, change orders, tracking project performance versus budget, and monitoring pipeline regarding industry best practices.
  • By analyzing revenue and gross margin by project type (fixed price and time and materials) and customer, Opportune was able to identify low margin projects and customers that the Company might want to divert resources from in the future. In addition, Opportune was able to flag customers, which accounted for a large portion of revenues and therefore represented a concentration of risk.
  • For income tax purposes, Opportune’s approach was three-fold:
    • Leverage quality of earnings procedures and findings to efficiently gain an understanding of the Target’s day-to-day activity that could affect the tax treatment to the Buyer (if inherited);
    • Perform income tax-specific procedures to identify appropriate tax jurisdictions where the Target conducted business, which provides a basis for an assessment of potential uncertain tax positions in the past along with a forecast of the likely results of combining the Target’s activity with the Buyers; and
    • Understanding each of the Target’s and Buyer’s ownership structure to work with Buyer and Target legal counsel on proposing an acquisition pattern resulting in the best after-tax result for the Buyer, with minimal impact to the Target. This analysis, which drew on all Opportune work to date, allowed us to estimate the manageable additional tax cost to the Target’s stakeholders resulting in a complete tax basis step-up to the Buyer that resulted in tax savings to the Buyer (using present value concepts) of just over 10% of the purchase price.

Opportune’s output not only assisted management in making their investment decision but highlighted areas of risk and complexity to support management in negotiations with the Target and integration into their portfolio.

Leveraging our Transactional Due Diligence practice, Opportune’s team of seasoned former Big 4 auditors, tax professionals, and industry experts bring the experience and tools necessary to evaluate the company’s earnings’ stability and persistence. When assessing the quality of an entity’s earnings, we consider the accounting practices, internal control environment, management experience, capacity to deliver on growth projections, macroeconomic influences, and cash flow stability. For more information on how we bring value to the quality of earnings analysis and related services, CLICK HERE.

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Byrony Coan

Byrony Coan


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