Last year we embarked on a due diligence engagement, our role to interrogate the historic financial performance and assess the veracity of forecasts prepared by the target company. We were working on behalf of a VC investor.
The investee Group had grown rapidly since its inception, global turnover was in excess of $10m, and it was looking to raise a significant level of funding to sustain trading and fuel further growth.
It became apparent early into our engagement that whilst the growth of the Group had been rapid the finance function was not sufficiently established to service the requirements of a business of the scale it now was.
We reported to the VC investor early that there were significant issues with the Group’s financial management.
A selection of the issues we uncovered included:
- No Group accounts available
- No consolidated reporting process (no visibility of Group position)
- Finance function operating and reporting on a cash basis rather than accruals basis
- Inaccuracies in balances arising from system errors arising from system interactions
- Unreconciled intercompany and reserve movements from prior periods
- Finance function under resourced
The investors were disappointed, with the Group being operationally astute and operating as a key player in their sector.
The risks to the investors without the financial reassurance sought from a due diligence exercise were just too great and the investment was not made at the time.
We outlined the above issues as matters which we would recommend being resolved prior to an investment decision being made.
Target company implementation
To address the issues identified in our phase 1 engagement, the Group developed a transformation plan. This aimed to take the Group from the current limited financial reporting framework to where they wanted to be – automated and consolidated month end reporting process with a timeline set to achieve this.
The result of the plan was that the Group did implement an automated month end process for preparing a consolidated management accounts pack (P&L, balance sheet and cash flow).
The Group also sought to bolster the finance team through recruitment.
Early this year we were approached by the investors who had maintained an interest in the Group and continued to monitor its progress.
We were subsequently asked by the investor to review the changes the Group had made and undertake a review of the current financial position.
We were able to obtain a fuller picture and following this the investors completed their investment into the Group.
This case highlights the importance and power of the diligence process. It should not be viewed as a ‘tick box’ exercise from the investor perspective as it can sometimes be regarded. It is evident from this case that it is a valuable exercise in assisting both the investor and the investee.
By improving the financial reporting and putting in place an automated month end process the Group now has a valuable management tool. This tool yields reliable and accurate financial information. This allows management to understand easily where the Group is performing well but where there may be issues. By being able to identify these ‘issues’ management have the ability to act quickly to make changes.
Without the diligence exercise the Group may have struggled to identify what needed to be done and how to implement this.
Finance team members found the exercise beneficial and indicated our phase 1 work gave weighting to them as a team to underline to Group management the importance of a strong finance operation.
This case highlights the diligence process is a valuable exercise and should not be underestimated from the investors or the investees perspective – it can be a learning opportunity for both.
Results of this case:
- Investment made with clear understanding of the risks
- Target company made improvements it was otherwise avoiding