Financial Due Diligence in Mergers and Acquisitions Social Care Sector

Author Rachael Anstee Specialist Accountant & Advisor to the Social Care and Children’s Nursery Sector (Hazlewoods Healthcare) In discussion with Buyacarehome and Ownacarehome

When acquiring another business, a buyer will want to gain some assurances over what they are acquiring including the sustainable earnings of the business, company valuation, working capital requirements, tax risks amongst other things.  They would get this comfort through carrying out financial due diligence, which is a fundamental process for any successful merger or acquisition.

The depth of due diligence required will depend on the complexity and structure of the transaction.  A more thorough due diligence process would typically be needed on any share acquisition (as opposed to the purchase of the business trade and assets) given that the buyer would be taking on the entire tax history of the company.  As well as financial and tax due diligence, a buyer may carry out further due diligence covering property, legal, commercial and operational aspects.

This article focusses on the importance of undertaking buy-side financial due diligence for any social care operator looking to expand through acquisition.

What is Financial Due Diligence? 

Financial due diligence is a process that involves analysis and interpretation of the underlying trading performance and financial position of a company to enable investors, lenders and acquirers to make informed decisions about whether to proceed with a transaction.

The due diligence process can also identify key risks and operational challenges that a buyer may need to consider when integrating the business with their existing systems and processes.

It may be appropriate for certain risks to be captured in the legal documentation by way of indemnity of specific warranties to give the buyer protection from legacy liabilities that may crystalise post-completion. Such risks can be identified through the financial and tax due diligence process.

Through a review of the underlying accounting records and mid-month cash movements, the financial due diligence will identify the working capital requirements of the target company.  The working capital shows the level of cash locked up in the business and therefore the cash needed to fund day-to-day operations. A working capital target will need to be negotiated for inclusion in the Share Purchase Agreement and the due diligence will help ensure that the buyer does not have to inject further capital into the target company post-completion (and therefore paying more for the business) in order to fund working capital requirements.

How Long Does the Financial Due Diligence Process Take?

Once an agreement in principle has been made between a buyer and seller, the key terms of the proposed transaction including the consideration payable is set out in a document called the Heads of Agreement.  Whilst this is not a legally binding document, the Heads of Agreement stipulate certain deal criteria, which helps avoid dispute and misunderstanding later in the transaction process.

The parties would typically agree a period of exclusivity, which gives the buyer sufficient time to carry out detailed due diligence to get the level of comfort they need to proceed with the transaction.

There is no fixed timeframe as to how long the due diligence process takes but a period three months exclusivity is fairly typically in other transactions we have advised on in the social care sector.

It is crucial to allow sufficient time to carry out a thorough due diligence process given the outcome could reveal valuable information essential to negotiating a fair purchase price and the identification of any legacy liabilities that may crystalise post-acquisition that a buyer would want appropriate protection from in the legal documentation.

Financial due diligence can be performed internally by the buyer's finance department or externally by independent experts.  In some cases, investors may stipulate that financial due diligence is conducted by someone independent in order for them to obtain sufficient comfort that their investment is viable.

Using specialist advisers like the Hazlewoods Corporate Finance team is recommended.  An advisor with sector expertise knows the challenges currently facing the social care sector and can provide real value in understanding how target companies are addressing these.  

By outsourcing the due diligence process, you get piece of mind that any financial or tax risks will be identified with appropriate recommendations as to how these can be mitigated.

What are the Benefits of Conducting a Financial Due Diligence Review?

In general, the results of a financial due diligence review should be able to answer the following questions: 

• Is the information provided by the target or vendor reliable?
• Are the historical earnings of the company sustainable and are they representative of anticipated future earnings?
• What are the potential future earnings of the target company?
• Are there any synergistic benefits associated with the proposed acquisition?
• What are the immediate and future tax consequences of the proposed acquisition?
• What plans need to be in place for the post-merger implementation process?
• Is the purchase price reasonable given the results of the due diligence process and in particular, the sustainable earnings review?
• Are there any red flag observations that may mean the deal is not viable?
• Is the proposed acquisition structure appropriate or is there any pre-completion reorganisation required to affect the transaction?

Conclusion

Financial due diligence is a vital part of any successful merger and acquisition process and can provide the level of comfort you need in proceeding with a potential acquisition.

The HazlewoodsCorporate Finance team has relevant care sector expertise and experience to efficiently identify financial and tax risks that need to be addressed prior to completing a transaction.

If you are a social care operator and looking to expand through acquisition, our Corporate Finance team would be delighted to explore the opportunity with you in further detail.