Due diligence: Moving up the knowledge value chain

By James R. Florin, CPA
Senior Financial Manager, Lucent Technologies

Competitive forces have led many companies to transform themselves via acquisitions, mergers and divestitures. If your employer is involved in any of these initiatives, or if you work for a closely-held company considering an initial public offering, there may be an opportunity — not to be missed — to participate in due diligence activities.

Importance of due diligence

And why, you ask, is due diligence so important? Well, with respect to acquisitions, the "caveat emptor" (let the buyer beware) axiom is paramount. Since the Seller is packaging the entity to its maximum advantage, due diligence will confirm your company's (the Buyer's) understanding and expectations of what it is buying and help clarify opportunities inherent in the acquisition. Due diligence will also help to control risk by obtaining detailed knowledge prior to closing the deal.

In many cases, outside experts are retained to handle most of what constitutes due diligence activities. Companies, however, increasingly are using internal staff to satisfy the financial aspects of due diligence requirements. After all, who knows more about your company and your business than you do? Who is in a better position to provide leadership and prognostic responses to questions from executive management?

Findings from the exercise of due diligence can often be quantified and translated into value, and may lead to a purchase price adjustment or modifications to the terms and conditions of the agreement that are beneficial to your company. Knowledge and insight of the "big picture," as it pertains to your company, can be critical to the bottom line.

Creating new opportunities

Involvement in due diligence activities would be a classic example of realizing the CPA Vision Project's Vision Statement, which asserts, in part, that:

CPAs deliver value by:

communicating the total picture with clarity and objectivity;
translating complex information into critical knowledge;
anticipating and creating opportunities;
designing pathways that transform vision into reality.

As you become immersed in due diligence activities, you will be amazed by your growing insight into how financial processes work, as well as your understanding of the degree to which those processes reflect the financial effects of business operations. You will see various types of businesses, technologies and products and services that do not currently exist within your company. You'll also encounter concepts and environments that may be vastly different from what you have experienced. Some examples are different corporate cultures, accounting policies and practices, business approaches and trends, start-up strategies, venture capital funding and accounting systems and general ledger packages.

You will learn, or learn a lot more, about:

deal structuring;
compensation packages & stock option plans (a real eye-opener);
risk management (derivatives, insurance);
international accounting techniques;
intellectual property issues.

Possible challenges

Be aware that you will confront hurdles. There may be problems obtaining access to target company information and auditors' work papers, and you may face issues with the indemnification language within the standard work paper access letter. Additionally, you may be required to travel on very short notice, encounter language barriers with international acquisitions and need to work with target company people who are not enthusiastic about the potential acquisition or who do not fully understand the process.

You may be surprised by some rather aggressive accounting treatment by the target company. It's important to keep in mind that while Generally Accepted Accounting Principles (GAAP) provide a solid framework, there are a number of acceptable treatments under GAAP that can have a material effect on both price and value. Identifying these areas could lead to some interesting discussions between the Buyer and Seller. There could also be roadblocks to obtaining and sharing proprietary information, and, most importantly, everything you do will need to be strictly confidential. But not to worry! Chalk it up to a great learning experience and a triple A investment in your career.

Becoming involved

So, how do you become involved? Use your internal network to determine if due diligence opportunities exist and volunteer to participate, even if only on a part-time basis. As CPAs, we enjoy a competitive advantage in that we are known for our integrity and competence, and we are widely regarded as trustworthy advisors to our employers. We should leverage that status and move up the knowledge value chain by seizing opportunities and cultivating an entrepreneurial mindset. Due diligence activities will move us in that direction and our professional reputation will be enhanced.

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