WHAT DOES A DUE DILIGENCE MANDATE LOOK LIKE?
Every deal is different. Kalos custom tailors its services to fit your needs. Generally speaking, we support our clients with the following deliverables:
We're here first and foremost to be your advisor and assist you through every step of the deal. Kalos identifies nuances in the transaction to arm its clients with the right questions to ask as well as points to leverage in their favour for a better negotiating position. Put our extensive deals, accounting and finance experience to work for you to obtain the best results possible.
Kalos reports detail the results of our analysis and outlines our thoughts on key deal areas and their implications. Sections of the report include an overview of the business, Quality of Earnings, Net Working Capital, Debt and Debt-Like, Capex, Forecast. We also provide a description of each operating segment (division, geography and product), as appropriate, with analytics and commentary on historical performance. Our reports are written in an objective and independent manner such that they can be used to obtain bank financing or be presented to an investment committee.
A databook is an excel workbook of detailed quantitative analysis for the deal. The analysis supports the evaluation of each element of the purchase price, analyzes business performance (by geography, division, product, etc.), as well as evaluates free cash flow and the Company's forecast. On a sell side engagement, Kalos provides unbranded schedules to support Management in preparation of the sale on request.
Management meetings are a key opportunity to determine the deal's quality. A typical deal only provides a couple of hours of access to the Management team to ask questions. Make the best of your time by having professionals experienced in leading these meetings guide the discussions. On the sell side, we help prepare Management ahead of meetings to gain potential buyers' confidence.
GENERAL BUSINESS DILIGENCE
Does the company generate the majority of its earnings from one key customer? Is a contract with a major supplier about to expire indicating the business will face higher costs going forward? Is a certain line of business, geography or product carrying the performance of the company while others detract? Does the business face obsolescence or disruption based on new regulations?
Numbers tell the story of the business. We look at historical and forecast financial information not only to pull out adjustments to the purchase price, but to truly understand the business. We examine performance by division, product, and geography as well as key performance indicators including pricing and volume trends, utilization, etc. In addition to the numbers, we ask questions of the management team to further understand the company and uncover potential risks and opportunities.
Before moving forward, the buyer should have a holistic view of the Company, its operations, financial performance and what's next.
QUALITY OF EARNINGS
Quality of earnings is the determination of a company's pro forma, normalized and adjusted EBITDA. This is performed by assessing the Company's historical performance, analyzing accounting implications and pro forma adjustments, identifying anomalies to be normalized, and considering changes expected in the forecast. Adjusted EBITDA is more art than science and contains numerous areas of professional judgement, which is where our vast deal experience can help navigate the grey.
FREE CASH FLOW
Cash is king. While a company may generate great earnings, it is important to understand (after considering non-cash accounting adjustments, debt servicing requirements and maintenance capital) how much cash the company is producing.
While a seller may not be basing their purchase price on forecast potential, it is still critical to understand the projected performance of the target and any future plans for the business. Kalos will assess the reasonableness of Management's forecast, including its assumptions, and consider implications to the transaction.
Kalos examines precedent transactions and comparable public company trading multiples in order to evaluate the appropriate multiple to be used on the deal. We take into consideration elements that are unique to the Company that should be reflected in the transaction multiple.
NET WORKING CAPITAL DEFINITION AND PEG
Beginning with the Company's historical financial performance and cash conversion cycle trends, we establish a base line for the Company's net working capital requirements. Similar to Adjusted EBITDA, Kalos adjusts net working capital for one-time items, accounting impacts and changes to the business. We determine which elements of the Company's current assets and current liabilities are truly net working capital and define the calculation of net working capital for the purposes of the transaction.
Kalos also examines whether the Company will have increased working capital requirements going forward, particularly if the forecast depicts a ramp up of earnings. We then subsequently calculate the impact of increased earnings on the required net working capital levels, which tend to be correlated, in establishing the peg. The peg is the value determined to be the appropriate amount of working capital to be left in the business on close. At close, the actual net working capital is calculated based on the definition, and any difference to the peg forms the adjustment to the purchase price.
MAINTENANCE VS GROWTH CAPEX
We analyze past capital expenditures to understand the level of capital investment required to maintain the status-quo. To the extent past expenditure levels demonstrate a slow-down to current, we evaluate a discount to the purchase price to reflect historical maintenance requirements that went unfulfilled prior to close.
In addition to assessing capital requirements to maintain status-quo earnings, known as maintenance capital, Kalos evaluates capital needs to grow the business as well as the amount of growth capital previously employed in the business. Maintenance capital is critical as, without it, the business will decline and is viewed as a mandatory spend. Growth capital is discretionary and could be deferred if necessary.
NON-OPERATING AND SURPLUS ASSETS
Some companies contain ancillary operations and non-core assets that a prospective buyer does not want to take on as part of their purchase. As an example, an owner may have an asset held in the company such as property or a vehicle that is more of a personal asset that needs to be carved out of the transaction.
DEBT AND DEBT-LIKE ITEMS
Debt and debt-like items is a schedule we prepare that shows the Company's net debt position. This is then used as the basis for calculating the purchase price from the enterprise value. Not all of a company's liabilities and commitments are recorded on its balance sheet - thus "debt-like" items. Debt-like items include contingent lawsuits, environmental or other regulatory responsibilities, etc. When purchasing the equity of a company, you become responsible for the Company's liabilities, so it is critical to understand what you are getting yourself into.