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Understanding the risks associated with inadequate due diligence during a business acquisition or merger requires careful attention to what was investigated, what may have been missed, and when the issue was discovered. We are here to help. As you evaluate the information below, you remain in complete control of your timeline, options, and decisions.
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Where Are You in the Process?
A lack of due diligence does not always become apparent at the same point in a business acquisition or merger.
You may still be evaluating the transaction and wondering whether important questions have been overlooked. Due diligence may already be underway, but financial records, contracts, ownership information, tax matters, or other details are not reconciling. You may be approaching closing with unresolved concerns. Or the transaction may already be complete, and you have discovered something you did not know when you agreed to the deal.
Where you are in the transaction matters because the options available before closing may be very different from those available afterward.
Consider which of the following situations most closely reflects where you are today.
You Are Considering an Acquisition and Are Concerned About What You May Be Missing
The business appears promising, but you are not yet confident that the information provided tells the whole story.
- The financial information supports the opportunity, but you want independent verification.
- Important customer, vendor, employee, or other relationships may be critical to the company's value.
- Ownership of assets, intellectual property, licenses, or other rights may need to be confirmed.
- Tax, employment, litigation, regulatory, or other liabilities may not be immediately apparent.
- You are concerned that something material may remain undiscovered before closing.
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Due Diligence Has Begun, But Something Does Not Add Up
You have started reviewing the business and found information that is incomplete, inconsistent, unexpected, or difficult to reconcile.
- Financial statements, tax returns, or accounting records do not fully align.
- An important contract, record, agreement, or explanation is missing.
- Revenue, expenses, ownership, or liabilities differ from what you expected.
- A tax, employment, regulatory, litigation, or other issue has surfaced during review.
- You do not yet know whether the discrepancy is minor or material to the transaction.
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You Are Approaching Closing, But Important Questions Remain Unresolved
The transaction is moving toward completion even though one or more material issues have not been satisfactorily answered.
- A third-party consent or approval has not yet been obtained.
- Financial information or ownership of an important asset remains unverified.
- A tax, employment, contractual, regulatory, or other issue remains open.
- The parties have invested substantial time and resources, increasing pressure to proceed.
- You are concerned that closing may occur before an important question is resolved.
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The Transaction Has Closed, and You Have Discovered Something You Did Not Expect
After closing, you have found information or circumstances that differ materially from what you understood before the transaction was completed.
- Revenue, earnings, assets, or liabilities are not what you expected.
- A significant customer, contract, employee, license, or business relationship is at risk.
- An undisclosed tax, employment, regulatory, litigation, or other liability has surfaced.
- Ownership of intellectual property or another important asset is now being questioned.
- You believe something material may have been missed, misstated, or inadequately investigated before closing.
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Verify the Business Before You Commit to What You Have Been Told
A promising acquisition usually begins with information supplied by the seller, management, brokers, financial statements, tax returns, projections, contracts, and conversations with people who know the business.
That information is necessary. It is not the same as verification.
Before substantial capital is committed, the assumptions supporting the transaction should be tested. Revenue and earnings should be examined against underlying records. Ownership of important assets and intellectual property should be confirmed. Material contracts should be reviewed for assignment and change-of-control issues. Customer and vendor concentration, key employee dependencies, tax exposure, regulatory obligations, litigation, and other potential liabilities should be understood in the context of the transaction.
The purpose is not to search for reasons to defeat an otherwise sound acquisition.
The purpose is to determine whether the business you are actually acquiring supports the price, structure, expectations, and risks upon which the proposed transaction is based.
The earlier that work begins, the more opportunity there may be to investigate concerns without allowing the momentum of the transaction to dictate the result.
The Next Action Step:
Gain insight and guidance through a complimentary and substantive consultation. We invite you to access our chat module, Schedule Your Complimentary Assessment or call (866) 631-3470 to begin the process of understanding the proposed transaction, identifying what should be verified, and protecting your legal, financial, tax, and business interests.
Determine Why the Information Does Not Add Up Before Assuming There Is an Innocent Explanation
A discrepancy discovered during due diligence does not necessarily mean that someone has done something wrong. Accounting methods differ. Records may be incomplete. Timing differences can affect financial reporting. Agreements may have been amended. An unusual transaction may have a legitimate business explanation.
But a material inconsistency should be resolved rather than explained away.
If financial statements do not reconcile with tax returns or accounting records, the underlying transactions may need to be examined. If revenue has changed unexpectedly, it may be necessary to understand the customers and transactions producing it. If liabilities, ownership interests, payments, related-party transactions, or other records raise questions, the investigation may need to extend beyond the documents initially provided.
This is one of the circumstances in which integrated accounting, legal, tax, and business analysis can materially change the quality of due diligence. A financial discrepancy may have a tax consequence. An accounting irregularity may affect a representation in the purchase agreement. An unexplained payment may reveal an undisclosed obligation or related-party relationship.
The first question is not whether the discrepancy kills the deal. The first question is what actually happened and whether the answer changes the value, risk, structure, or assumptions underlying the transaction.
Where ordinary review cannot satisfactorily explain the records, forensic accounting may provide a deeper examination of transactions, financial activity, ownership, and the evidence behind the numbers.
The Next Action Step:
Gain insight and guidance through a complimentary and substantive consultation. We invite you to access our chat module, Schedule Your Complimentary Assessment or call (866) 631-3470 to discuss the discrepancies you have identified, the information available, what may require further investigation, and how those findings may affect the proposed transaction.
Resolve Material Questions Before the Momentum of the Transaction Becomes the Reason to Close
Approaching closing changes the atmosphere surrounding an acquisition.
The parties may have spent months negotiating. Professional fees have accumulated. Financing may be ready. Employees, landlords, customers, vendors, lenders, and other parties may have been brought into the process. There may be significant financial and operational reasons to close on schedule.
None of those facts answers an unresolved due diligence question.
A missing consent may affect whether an important contract survives. Unverified financial information may affect valuation. An unresolved tax issue may create exposure that has not been allocated. Questions involving ownership, employees, intellectual property, regulatory compliance, or other material matters may require additional investigation or corrective action before closing.
A closing date is a transactional objective. It should not become a substitute for obtaining information necessary to make an informed decision.
If the issue can be understood and quantified, the parties may be able to address it through remediation, a consent or clearance, a purchase price adjustment, revised transaction terms, a specific indemnity, escrow or holdback, additional closing conditions, or another structural protection.
If the issue changes a fundamental assumption underlying the transaction, the decision may be more significant.
The important point is to determine which type of problem you have before the transaction closes and your available options materially change.
The Next Action Step:
Gain insight and guidance through a complimentary and substantive consultation. We invite you to access our chat module, Schedule Your Complimentary Assessment or call (866) 631-3470 to evaluate the unresolved issue, its potential effect upon the transaction, and the legal, tax, accounting, financial, or structural options that may remain available before closing.
Determine What Happened, What the Transaction Documents Provide, and What Options Remain After Closing
Discovering a material problem after an acquisition is fundamentally different from discovering it during due diligence.
The transaction has occurred. The purchase price has been paid or committed. Ownership has transferred. The buyer may already be operating the company. The problem is no longer something that can simply be considered before deciding whether to proceed.
The first task is to establish the facts.
What information was provided during due diligence? What was represented about the business? What appeared in the disclosure schedules? What did the buyer know before closing? What does the purchase agreement provide regarding representations, warranties, covenants, indemnification, escrow, holdbacks, notice requirements, limitations, and dispute resolution?
The financial impact must also be understood. If revenue, earnings, liabilities, taxes, assets, customer relationships, or other important facts were materially different from what was understood before closing, accounting or forensic analysis may be necessary to establish what occurred and quantify the resulting effect.
Do not begin with the assumption that every post-closing problem creates a claim against the seller. Begin by establishing what happened, what was represented and disclosed, what the agreement provides, what financial consequences resulted, and whether legal or contractual remedies may be available.
Timing may matter. Purchase agreements can contain specific procedures and deadlines governing post-closing claims. Evidence may also become more difficult to reconstruct as employees leave, records change, transactions continue, and memories fade.
The Next Action Step:
Gain insight and guidance through a complimentary and substantive consultation. We invite you to access our chat module, Schedule Your Complimentary Assessment or call (866) 631-3470 to review what has been discovered, the transaction documents and financial evidence, the potential consequences, and the options available to protect your interests moving forward.
The Most Important Thing to Know About a Lack of Due Diligence During a Business Acquisition or Merger
Before closing, a problem discovered through due diligence is information you can act upon. After closing, that same problem may become a financial loss, operational challenge, legal dispute, tax exposure, or liability you already own.
That difference is why the timing and quality of due diligence matter.
Before the transaction closes, a buyer may still have substantial leverage and meaningful choices. You may be able to request additional records, independently verify important information, investigate a discrepancy, require corrective action, obtain a necessary consent or clearance, renegotiate the purchase price, modify the structure of the transaction, establish an escrow or holdback, require specific contractual protections, postpone closing, or decide that the transaction should not proceed.
After closing, many of those choices may no longer exist.
The question may instead become what the purchase agreement provides, what the seller represented or disclosed, whether contractual protections apply, what evidence establishes the problem, how much financial harm has resulted, whether another party bears responsibility, and what remedies remain available.
The most dangerous due diligence problem is not necessarily the largest problem. It may be the material issue that remains an assumption until after the buyer has surrendered the ability to respond to it before closing.
This is also why due diligence should not be measured simply by the number of documents collected, boxes checked, or questions answered. A financial statement may raise a tax question. A tax return may expose an accounting inconsistency. A customer contract may reveal that expected revenue is less secure than anticipated. An employment issue may create an undisclosed liability. Questions surrounding intellectual property, licenses, regulatory compliance, ownership, or key personnel may materially affect whether the business can operate after the transaction as expected.
The objective is to understand how those findings affect the business as a whole and the transaction you are actually considering.
Do Not Allow the Momentum of the Transaction to Answer an Unresolved Question
Business acquisitions develop momentum. The parties negotiate. Attorneys draft agreements. Accountants review records. Financing is arranged. Closing dates are established. Considerable time, money, and effort may already have been invested.
That momentum can create its own pressure to finish.
But the amount already invested in a transaction does not reduce the significance of information that has not been satisfactorily verified.
If an unresolved issue could materially affect the value of the business, the liabilities you may assume, the assets or rights you will actually receive, the company's ability to operate, or the economics of the transaction, the appropriate time to understand it is while you still have meaningful options.
Some findings can be explained. Some can be corrected. Some can be quantified and addressed through price, structure, indemnification, escrow, or other protections. Others may change the fundamental assumptions upon which the transaction was negotiated.
Knowing the difference is one of the principal purposes of due diligence.
Integrated Professional Analysis Can Change What You See—and What You Can Do About It
Allen Barron brings legal, tax, accounting, and business consulting disciplines together to examine significant business transactions from perspectives that should not always be separated. What appears to be an accounting issue may create legal or tax consequences. A contractual problem may affect valuation or future operations. A tax exposure may change transaction structure. A financial irregularity may require forensic examination before its significance can be understood.
The value of integrated due diligence is not simply having several professionals review the same transaction. It is understanding how a finding in one discipline changes the questions that should be asked—and the decisions that should be made—in the others.
We invite you to learn more about the integrated tax, legal, accounting and business consulting services of Allen Barron. Contact us or call (866) 631-3470 to schedule a complimentary and substantive consultation regarding your transaction, concerns, and objectives. Ask about the protections of the attorney-client privilege and the advantages of coordinating legal, accounting, tax, and business analysis before an unresolved issue becomes a completed transaction.
What Can Happen When Due Diligence Is Incomplete?
The risks associated with inadequate due diligence can extend well beyond discovering an unexpected expense after the transaction closes.
A business acquisition is based upon a series of assumptions about value, earnings, assets, liabilities, customers, employees, contracts, intellectual property, taxes, operations, and the company's ability to continue producing results under new ownership. Due diligence provides an opportunity to test those assumptions against financial records, agreements, external verification, operational evidence, and the actual circumstances of the business.
When an important assumption is not adequately investigated, the buyer may not simply inherit an unexpected problem. The buyer may have agreed to a price, structure, or allocation of risk that would have been materially different if the facts had been known before closing.
The amount of investigation appropriate to a transaction will vary. The size of the acquisition, amount of capital at risk, complexity of the target company, reliability of its records, nature of its products or services, available time and resources, and risks associated with its industry and operations may all affect the scope of due diligence.
What should not change is the objective: identify and understand material issues while there is still an opportunity to determine what they mean to the proposed transaction.
01
The Business May Not Be Worth What You Thought
Purchase price discussions often begin with financial statements, tax returns, historical earnings, projections, assets, cash flow, and expectations about future performance.
Those numbers require context.
Revenue may depend heavily upon one or two customers. Reported earnings may include unusual or nonrecurring transactions. Expenses may have been deferred, understated, or treated differently than they will be under new ownership. Accounts receivable may not be as collectible as they appear. Working capital requirements may be greater than anticipated. Related-party transactions or owner-specific expenses may complicate the financial picture.
The records may also reveal inconsistencies that require deeper accounting or forensic analysis before their significance can be understood.
The question is not simply whether the company's financial statements are mathematically accurate. It is whether the underlying financial evidence supports the earnings, cash flow, assets, liabilities, and sustainable economic value upon which the buyer is relying.
If it does not, the purchase price or other economic terms of the transaction may need to change.
Important Contracts and Business Relationships May Not Survive the Transaction
A company can appear financially strong while depending upon relationships that are more fragile than its historical results suggest.
An important customer agreement may contain an assignment or change-of-control provision. A landlord's consent may be required. A supplier may have termination rights. A license may be personal to the existing entity or owner. A significant customer relationship may depend heavily upon the seller rather than the company itself.
Key employees can present similar concerns. If specialized knowledge, customer relationships, technical expertise, licenses, or management responsibilities are concentrated in a few people, their departure may materially affect the business after closing.
Due diligence should therefore examine more than what relationships existed historically.
It should determine which relationships are necessary to preserve the value of the business, whether they will actually continue after the transaction, and what must happen before closing to protect them.
02
03
You May Discover Liabilities That Were Never Reflected in the Purchase Price
Not every material obligation appears prominently on a balance sheet.
Unresolved tax matters, payroll obligations, employment claims, worker classification issues, pending or threatened litigation, regulatory violations, contractual commitments, liens, guarantees, environmental concerns, warranty obligations, or other historical exposures may materially affect the economics of an acquisition.
The transaction structure matters, but it should not be assumed that purchasing assets rather than equity automatically eliminates every historical risk associated with the seller or acquired operation.
This is one reason due diligence may require coordinated legal, tax and accounting review. A financial entry that appears insignificant to one discipline may reveal an exposure that becomes much more consequential when examined from another.
A liability identified before closing can be investigated, quantified, allocated, addressed in the transaction documents, reflected in the purchase price, or—in appropriate circumstances—resolved before the buyer assumes control. An undiscovered liability provides none of those advantages.
The Business May Not Own Everything You Thought You Were Buying
The value of a business may depend upon much more than physical equipment and inventory.
Trademarks, copyrights, proprietary software, trade secrets, domain names, customer information, licenses, formulas, processes, technology, contractual rights, equipment, real property interests, and other assets may be central to the company's ability to operate.
Due diligence should establish not only that an asset exists, but who owns it and whether the buyer will actually receive the rights necessary to use it after closing.
An intellectual property asset may have been created by an employee, contractor, founder, or third party without an adequate assignment. Equipment may be leased rather than owned. Software may be subject to licensing restrictions. A permit or operating license may require approval before transfer. Another party may have a lien or competing interest in an important asset.
If an asset or right is fundamental to the value of the business, uncertainty concerning its ownership or transferability is not a paperwork problem. It may be a transaction problem.
04
Historical Performance May Not Continue After Closing
Historical financial performance tells you what the business did. An acquisition depends upon whether the conditions that produced those results can continue.
That distinction is easy to underestimate.
Customers must remain. Vendors must continue supplying. Employees and management may need to stay. Contracts must remain effective. Intellectual property and licenses must be available. Systems must continue functioning. Working capital must be sufficient. The company must remain capable of producing its goods or delivering its services after ownership changes.
Market position and competitive conditions may matter as well. Due diligence may require examination beyond the company's internal records, including external sources, industry information, customers, suppliers, and other evidence capable of testing management's assumptions about the future of the business.
A buyer is not purchasing last year's revenue or earnings. The buyer is acquiring the assets, rights, relationships, people, systems, goodwill, obligations, and operating conditions expected to produce results after closing.
That is why effective due diligence is ultimately about more than finding mistakes.
It is about determining whether the business that will exist after the transaction is reasonably consistent with the business upon which the buyer's decision, valuation, and expectations were based.
What Happens When Due Diligence Identifies a Problem Before—or After—the Transaction Closes?
The discovery of a material problem does not occur in a vacuum. When it is discovered can substantially affect what can be done about it.
Before closing, the parties are still negotiating a transaction that has not been completed. The buyer may retain leverage, contractual rights, access to information, control over whether closing conditions have been satisfied, and ultimately the ability to decide whether to proceed.
After closing, the transaction has changed from a proposed investment into an accomplished fact. Money has changed hands. Assets or ownership interests have transferred. The buyer may be operating the company, employing its workforce, serving its customers, performing its contracts, and confronting the financial or operational consequences of the problem.
The same underlying problem can therefore present two very different challenges depending upon which side of the closing it is discovered.
The Buyer Still Has Choices
If the Problem Is Discovered Before Closing, Determine What It Means Before Deciding What to Do About It
The first response to an unexpected due diligence finding should usually be investigation rather than assumption.
What happened? Is the information accurate? Is the issue isolated or systemic? How long has it existed? What financial exposure does it create? Does it affect an asset, liability, contract, employee, customer, tax obligation, regulatory requirement, or another component of the business? Does it change valuation or expected future performance?
Additional records may need to be requested. Financial information may require independent verification. Contracts, corporate records, tax filings, ownership documents, correspondence, or underlying transactions may need closer examination. Management, accountants, employees, customers, vendors, landlords, or other parties may possess information necessary to understand the issue.
In some circumstances, accounting or forensic analysis may be necessary to determine what the records actually establish.
The objective is to move the issue from uncertainty to something the parties can understand well enough to make an informed decision.
Only then can the appropriate response be evaluated.
A Pre-Closing Problem May Be Correctable
Some diligence findings identify something that needs to happen before the transaction can safely proceed.
A missing contract consent may be obtained. Corporate records may be corrected. A lien may be satisfied. A tax issue may be resolved or an appropriate clearance obtained. Ownership of an asset may be documented. Intellectual property may be properly assigned. A regulatory or licensing requirement may be addressed. An accounting discrepancy may be reconciled.
In these situations, the discovery does not necessarily require a different economic bargain.
It may simply establish a condition that should be satisfied before the buyer closes.
That distinction matters. A buyer should not necessarily accept the risk of a problem merely because everyone believes it can eventually be corrected.
If resolution of an issue is important to the value, ownership, operation, or legal position of the acquired business, due diligence provides an opportunity to determine whether that resolution should occur before the buyer becomes responsible for the company.
Other Problems May Require Changes to the Transaction
A material finding may be legitimate and unavoidable, yet still alter the bargain originally contemplated by the parties.
The purchase price may need adjustment. A specific liability may require indemnification. Funds may need to remain in escrow or be subject to a holdback. Representations and warranties may need to become more specific. Disclosure schedules may require revision. Closing conditions may change. The allocation of assets or liabilities may need reconsideration. In some circumstances, the structure of the transaction itself may warrant additional analysis.
This is where legal, tax, accounting, financial, and business considerations can intersect quickly.
Changing the purchase price may have tax consequences. Changing transaction structure may alter which liabilities or assets transfer. An accounting finding may require contractual protection. An operational problem may affect working capital requirements or financing.
The appropriate response should address the actual risk discovered—not simply create the appearance that something has been done about it.
And Sometimes the Right Decision Is Not to Close
Not every problem can be corrected, adequately quantified, or transferred to someone else.
If a material assumption underlying the acquisition cannot be verified—or if due diligence establishes that the business is materially different from what the buyer intended to acquire—the buyer may need to reconsider whether the transaction remains acceptable.
That is not necessarily a failure of the acquisition process.
It may be precisely the loss that due diligence was intended to prevent.
The cost of walking away from a transaction can be substantial. The cost of closing a transaction that should not have closed can be substantially greater.
Learn More About Due Diligence in a Business Merger or Acquisition
Our comprehensive discussion of the investigation, verification, financial review, legal analysis, tax considerations, accounting issues, operational questions, red flags, and professional disciplines involved in the process is available at Due Diligence in Business Mergers and Acquisitions .
The Investigation Changes
What If the Problem Is Discovered After the Business Acquisition or Merger Has Closed?
After closing, the questions become different.
The buyer may no longer be deciding whether to accept the risk. The buyer may already be living with its consequences.
Perhaps revenue is materially lower than expected. A liability has surfaced. A significant customer has departed. A tax authority has asserted an obligation relating to periods before the acquisition. An employment or regulatory problem has emerged. Intellectual property ownership is being challenged. A critical contract cannot be used as anticipated. Accounting records reveal transactions that were not understood before closing.
Or the buyer has learned that information provided during the transaction may have been incomplete or inaccurate.
Start With What Was Known, Represented, Disclosed, and Agreed
The existence of an unexpected problem does not by itself establish who is legally or financially responsible for it.
The transaction must be reconstructed carefully.
What does the purchase agreement provide concerning indemnification, escrow, holdbacks, survival periods, notice requirements, limitations upon liability, dispute resolution, and available remedies?
The question is not simply whether the buyer received something different from what was expected. The question is why that happened, what the parties agreed concerning that risk, and what the governing transaction documents and applicable law provide.
Determine the Financial Consequence of What Was Missed
Legal rights are only part of the analysis.
The economic effect of the problem must also be established.
If revenues were overstated, by how much? If expenses or liabilities were omitted, what is their actual value? If a customer was lost, what revenue and profit were reasonably associated with that relationship? If accounting records were inaccurate, what do the underlying transactions show? If a tax liability relates to pre-closing activity, what periods and amounts are involved?
The answer may require accounting reconstruction, financial analysis, tax analysis, or forensic accounting.
This becomes particularly important when the dispute involves not merely whether something was inaccurate, but whether that inaccuracy materially affected the value of the business or the terms upon which the buyer agreed to acquire it.
Preserve the Records and Evidence Necessary to Understand What Happened
A post-closing problem can become harder to investigate as time passes.
Employees leave. Accounting systems change. Records are archived or overwritten. Emails become harder to locate. Memories fade. Relationships with former owners, accountants, vendors, customers, and employees change.
If a significant issue has surfaced, the underlying records should be identified and preserved.
That may include transaction documents, disclosure schedules, due diligence requests and responses, financial statements, tax returns, accounting data, emails, contracts, bank records, invoices, customer information, corporate records, and other evidence relevant to what was represented and what actually occurred.
Before conclusions are reached about responsibility or potential remedies, the evidence necessary to establish the facts should be protected and understood.
The Purchase Agreement May Establish Important Rights—and Important Limitations
Business acquisition agreements often contain detailed provisions governing what happens when a post-closing issue arises.
Representations and warranties may survive for specified periods. Particular liabilities may have special indemnification provisions. Claims may require notice within contractual deadlines. Escrows or holdbacks may remain available for limited periods. The agreement may establish procedures for asserting claims or resolving disputes.
The specific language matters.
So do the facts surrounding the issue.
A problem that was expressly disclosed may be treated differently from one that was not. A known risk allocated to the buyer may present a different analysis from an inaccurate representation. Fraud, concealment, contractual breach, indemnification, and other potential theories or defenses each depend upon the circumstances and applicable law.
Do not assume that discovering a serious problem means the seller automatically bears responsibility. Do not assume that closing means the buyer has no remaining protection either.
The transaction documents, evidence, timing, and nature of the conduct must be evaluated together.
What Happens Next Depends Upon What the Investigation Establishes
Some post-closing problems can still be resolved commercially.
The parties may agree upon an adjustment, payment, indemnification claim, escrow release, corrective action, tax treatment, operational solution, or another negotiated resolution.
Other matters may develop into formal disputes.
The important first step is not escalation for its own sake. It is developing a reliable understanding of the facts, financial consequences, contractual rights, legal issues, and practical objectives.
Closing changes the available options. It does not eliminate the need for careful investigation, disciplined analysis, or an informed strategy for protecting what remains at stake.
Why Integrated Expertise and Experience Matter When Something Was Missed
When due diligence identifies a significant problem—or a problem surfaces after the transaction has already closed—the issue rarely remains confined to a single professional discipline.
An accounting discrepancy may raise questions about representations made during the transaction. An undisclosed liability may affect both valuation and tax exposure. A contractual problem may threaten an important source of revenue. A customer relationship that does not survive the acquisition may change projected cash flow and working capital requirements. An employment or regulatory issue may create legal exposure while simultaneously affecting the future cost of operating the business.
This is where the ability to connect legal, tax, accounting, financial, and business consequences becomes particularly important.
Four Questions Bring the Transaction Into Focus
What Actually Happened?
Before deciding how to respond to a significant due diligence problem, the underlying facts must be established.
That may require examining accounting records, bank transactions, contracts, tax returns, invoices, correspondence, corporate records, due diligence responses, disclosure schedules, and other evidence surrounding the transaction.
Sometimes the issue is relatively straightforward. A record was missing. An accounting treatment requires explanation. A contractual obligation was misunderstood.
Other situations require considerably deeper investigation.
If financial information does not reconcile, transactions appear unusual, assets or liabilities were inaccurately presented, money moved through related entities, or representations concerning the financial condition of the business are being questioned, forensic accounting may be necessary to reconstruct what occurred.
What Is the Financial Impact?
Finding a problem and understanding its economic significance are two different things.
An inaccurate financial statement may matter because it affected reported earnings. A lost customer may matter because of the revenue and profit associated with that relationship. An undisclosed liability may require payment, but it may also affect cash flow, working capital, financing, taxes, or the amount the buyer would reasonably have paid for the business.
The analysis may therefore require more than calculating the immediate cost of correcting the problem.
Accounting and financial analysis can help establish the magnitude of the issue. Tax analysis may identify additional consequences. Business analysis can help determine whether the problem is temporary and manageable or whether it changes assumptions about future operations and profitability.
What Did the Parties Agree To?
Once the facts and financial consequences are better understood, the legal analysis becomes more focused.
The purchase agreement, representations and warranties, disclosure schedules, covenants, indemnification provisions, assumed and excluded liabilities, escrow or holdback arrangements, closing conditions, survival periods, notice requirements, and dispute resolution provisions may all affect what happens next.
The language of those documents should be evaluated against what actually occurred.
What Does the Problem Mean for the Business Going Forward?
Not every due diligence problem should be evaluated exclusively by looking backward.
The buyer still has a business to operate.
If an important customer has left, how dependent was the company upon that revenue? If a key employee departs, what knowledge or relationships leave with that person? If a supplier relationship changes, can the business obtain the same products, pricing, or terms elsewhere? If additional tax, regulatory, employment, or capital requirements have surfaced, how will they affect cash flow and future profitability?
A post-closing strategy that focuses exclusively upon who may be responsible for the problem can miss an equally important question:
Legal remedies and business solutions are not always the same thing. Depending upon the circumstances, both may need to be pursued simultaneously.
Experience Is Knowing Which Question to Ask Next
Complex business transactions do not organize their problems according to professional licenses.
An attorney may identify language in the purchase agreement that raises an accounting question. An accountant may identify a transaction that requires legal investigation. A tax professional may recognize that a proposed financial remedy creates an unintended tax consequence. A business advisor may identify an operational problem that changes the significance of what initially appeared to be a limited contractual issue.
That is precisely why the professional structure of Allen Barron can be so valuable when a significant problem arises during or after a business acquisition.
Connecting the Transaction as a Whole
Janathan L. Allen is an experienced California attorney with an L.L.M. Master of Laws as well as an MBA and accounting degrees whose work encompasses the legal, tax, accounting, financial, and business issues that frequently intersect in significant business transactions. Her multidisciplinary background provides an important perspective when the answer to one question changes the analysis required in another professional discipline.
She is supported by the integrated resources and professional experience of Allen Barron in matters involving business transactions, accounting and financial analysis, federal and California taxation, forensic accounting, business consulting, and related legal issues.
That can be particularly important when the original issue is not yet fully understood.
A discrepancy in the accounting records may ultimately affect valuation, taxes, contractual representations, or potential claims. An undisclosed tax obligation may affect cash flow as well as legal responsibility. A contractual problem may threaten an important customer relationship and therefore alter the financial outlook of the acquired company. A proposed resolution may solve one problem while creating another if its tax, legal, accounting, and business consequences are not considered together.
Allen Barron's Integrated Professional Services Help Connect the Findings to the Decisions
Allen Barron's integrated legal, tax, accounting and business consulting services allow significant due diligence findings to be evaluated across the professional disciplines they actually affect.
The objective is not to involve more professionals than the circumstances require.
It is to make sure that the right professional questions are being asked as the facts develop—and that an answer reached in one area is understood for the consequences it may create elsewhere in the transaction or business.
We invite you to learn more about Janathan L. Allen and the integrated professional services of Allen Barron. Contact us or call (866) 631-3470 to schedule a complimentary and substantive consultation regarding a due diligence concern discovered before or after a business acquisition or merger.