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When two companies engage in the mergers and acquisitions dance, negotiating price and signing a letter of intent is simply the start of the process. What follows is arguably the most important and time consuming step in an M&A deal: due diligence.

Due diligence allows the buyer to confirm that all of the information the seller has given is truthful and accurate, while also gathering further information that may not have been discussed. Verifying important variables like current contracts, getting an in-depth look at financial statements, and taking a look at customers are all key pieces of information that helps a business close the deal with confidence.

Read on to learn more about the due diligence process, and why it is a crucial component in mergers and acquisitions.

Why is due diligence important for private equity firms?

USC Consulting Group regularly performs due diligence deep dives for our Private Equity clients to discover the “truth” behind a company’s curtains. In pulling back those curtains, we’ve discovered that some businesses trying to be acquired fabricate their earnings and production numbers to seem more appealing and drive a higher selling price.

Performing due diligence exposes the real numbers of a potential acquisition. This process not only confirms that all of the information the seller has provided is accurate, but it also allows a buyer to verify any other important variables that may not have been discussed.

Here are some of the steps we take in performing due diligence for our clients.

Important steps in due diligence

Due diligence is a complicated process which can take anywhere from a few weeks to two months or more. Therefore, it’s important to hit a number of key benchmarks to make sure the process goes as smoothly and quickly as possible.

Gather the right team

A full due diligence analyzation requires looking over a multitude of the seller’s documents. These can range from financial reports to real estate holdings to sales figures, and anything else pertinent to the deal. You need people who can make sense of it all. Making sure you have members on your team who can properly understand and analyze these documents is crucial for establishing a clear picture of the seller’s business health.

Establish goals

Think about your corporate goals. What data is most important to you? What information do you absolutely need to verify? If some aspect of the seller’s business doesn’t meet expectations, what variable would constitute a deal-breaker?

Establishing goals before beginning a due diligence assessment serves as a compass of sorts to navigate your company through all the data and find what is most important for your corporate goals.

Gather and review important documents

This step is the meat of the due diligence process: gathering important documents from the seller and analyzing them with your team.

The exact documents you’ll need vary based on industry and type of merger or acquisition, but more often than not this will include financial statements, real estate or lease information, insurance, manufacturing operational data, and anything else that the buyer deems pertinent. Things to look for, specifically include:

This step goes hand in hand with gathering the right team, because it is important to have people in your company that know how to properly analyze and highlight important aspects of these documents.

Not just the what, but the how

Proper documentation and verification is vital. But it’s also important to take into account how they are being provided to you. Is the seller taking a long time delivering documents? Do you have to ask repeatedly? Are the documents arriving with inconsistencies or otherwise incomplete? Huge red flag. Conversely, is the seller being extremely cooperative, sending documents in-full and on time? Take note of the behind-the-scenes behavior of the seller to get a full picture of the company.

Re-evaluate information with your strategic goals

After all of the information provided by a seller is adequately analyzed, the final step for a buyer is to determine how to proceed.

How did these documents align with your strategic corporate goals that were established before the due diligence process? There may have been unexpected variables discovered during the process, both good and bad. Refer back to your corporate “compass” to determine if these should hold weight during your decision. Overall, does your team agree that it is wise to continue? Or was there something unearthed during the process that gives you pause?

USC can be your partner

Performing a successful mergers and acquisitions process is extremely complicated; this is just the tip of the iceberg. It requires the right team giving you the right information. At USC Consulting Group, we can help you paint a clear and realistic picture of the considered portfolio addition to help you make a confident decision about the future of your company. Whether performing due diligence efforts or improving the productivity and efficiency of a business already in your private equity portfolio, USC can help you.

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What a time to be a private equity fund manager. According to Preqin, worldwide private equity holdings in 2016 reached a value of nearly $2.5 trillion. Private Equity liquid assets increased by $65 billion between 2015 and 2016.

Nestled amid that growth lies food and beverage, historically one of the more dependable performers in the PE portfolio. Investment banking and wealth management firm William Blair predicted that the number of M&A transactions in food manufacturing in 2017 broke records, toppling all other yearly totals in the past decade.

With that said, food and beverage acquisitions in the U.S. aren’t always the slam dunks they appear to be. When considering any acquisition, firms should always take the proper general precautions as well as those specific to the industry they’re targeting. What factors should PEs consider when deciding whether to invest in a food and beverage company?

1. Labeling regulations and court decisions

Class-action lawsuits involving food labels have rocked the food and beverage industry of late, and how appellate courts respond to this tumult might ultimately dictate how PE firms settle on their best bets for a profitable acquisition.

A recent report from the Institute for Legal Reform found that a few instances of possible misleading labels made up a majority of the litigation:

Any PE firm investigating a possible acquisition should examine any possibility that its targets will suffer from lawsuits, or that upcoming regulatory changes from the Food and Drug Administration will force its prospective holdings – and by default, the firm – to spend on shifting compliance. This includes a review of current and future packaging, labeling processes, sourcing relationships, etc., as well as location. The aforementioned study revealed that three-quarters of labeling-related federal litigation occurred in California, New York, Florida or Illinois. Another 10 percent occurred in Missouri, New Jersey and Pennsylvania.

2. Specialty food opportunities

These days, the size of an F&B business is not as important as growth opportunities within an industry niche. Big companies with nothing new to offer will not see as much favor as smaller companies with new products to offer the market or new value-adds that resonate with consumers.

But a new flavor that draws in a once untargeted demographic or an attractive superfood ingredient isn’t nearly as important as evidence of sustainability – in both production and demand. Is this change a long-term value or a flash in the pan? Does the company have the bandwidth to meet capacity increases? Are sourcing relationships for new products as beneficial as they could be? Answers to these questions and more will demonstrate whether a company has what it takes to earn your acquisition and subsequent investment.

3. Plans for direct-to-consumer model

Amazon’s acquisition of Whole Foods sent a message to food and beverage manufacturers and retailers alike: There’s no ignoring the disruption caused by the direct-to-consumer model.

Consumer packaged goods producers on the table for acquisition have likely spent the past few years in a defensive cost-cutting posture, hoping to reduce opex without compromising on quality and mild operational expansion. This may be the reason why PEs are eyeing these businesses to begin with.

Amazon/Whole Foods, however, represents an industrywide challenge of sorts. CPG companies, acquired or not, must formulate solid plans for evolving their products based on this market movement. Should they have these plans in place upon a visit from a hungry PE firm, that firm must weigh the quality of that strategy as a considerable part of their internal valuation. Put another way: If the food and beverage company has little to no plan for facing the Uberification of groceries, PEs must take note. It’ll mean passing on the venture entirely or expending resources to develop a strategy once the company is acquired.

Packaging is one such determinant. Innovation-minded food and beverage manufacturers are less inclined to worry about shelf appeal and more inclined to consider meal kits, cost-effective packaging designs built for shipping and perhaps even a change in portion sizes. These businesses, however, must support these plans with evidence of progress to win the attention of PE firms.

Of course, no acquisition is a sure thing. After all, PE firms specialize in transforming underperforming businesses. But if your organization has struggled with turning around an asset in your portfolio, contact USC Consulting Group today. Our operations management team will help you create a system for immediate and continuous improvement based on years of industry knowledge.