Publications

The importance of due diligence on the composition of valuation in companies under M&A process

September / 2018

Companies are seeking to consolidate and/or expand their market share and to achieve it, the use many strategies. We will approach exclusively the due diligence, one of the vectors that dictate the composition of valuation in operations of merger and acquisition (or M&A¹ ) transactions.


M&A Timeline

It is natural that in times of economic crisis as we live many only see storms, but also natural that others look for outputs and identify opportunities that aim to soften the impacts caused by it and / or seek market strengthening operations for the perpetuation of its business in face of this scenario.

Currently, M&A transactions have expanded in Brazil and are even used by small and medium-sized companies. The thing is, whether in a large or a small operation, the negotiating always has to get in a common denominator in the company valuation, which is, the value of the company.


Price Composition - Valuation

It can be said that the price of a company is equivalent to its future cash generation capacity, which would technically be discounted to present value. In addition to the analysis of discounted cash flow, other usual methods of valuation include: (i) comparisons with similar and recent transactions; (ii) the price of similar size companies; and (iii) EBITDA² multiples. However, all these methods are having guidelines based in a given transaction.

Also, in the valuation are variables such as: (i) established customers relationships; (ii) maturity of the company, both in the economic/financial and governance aspects; (iii) core business profit margin; (iv) risks and financial results prospects, historical and projected, among others.


Due Diligence

Due to the variables related to the valuation composition, it is important to investigate the context in which the company is inserted, in order to indicate the financial, tax, labor, social security, legal, environmental status, etc.

The intention to sell must precede the sale planning, so of great value is the pre-sale checkup, called “sell-side due diligence”, followed by corrective actions. This checkup aims to carry out a comprehensive diagnosis of the company, with enough advance and accuracy to take corrective actions to avoid surprises at transaction closing and mitigating the loss of the sale value.

In the buyer's sell-side legal due diligence, the company seeks to evaluate the information, mapping the current legal situation of the company and its operations, in the following areas: corporate, contractual, regulatory, real estate, intellectual property, compliance with anti-corruption laws, environmental and litigation (judicial and/or administrative proceedings in civil/commercial, consumer, criminal, labor and tax matters in which the company is party or interested).

The due diligence process is carried out based on the documents provided by the company itself and its employees, as well as documentation provided by the public agents (municipal, state and federal). Naturally, there is nothing to prevent other sources of information from being used, if relevant.

After the process of document mapping and collection, all such data should be turned into information, which should be enough to establish the company's valuation as well as the strategy of the transaction.

Due diligence and careful preparation of documents (preparatory and definitive) is essential to avoid future problems and guarantee the security of the transaction.

Vernalha, Di Lascio, Mesquita & Associados is at your disposal for any further questions.


¹ “[…] Mergers and acquisitions (M&A) consist of deliberate transfers of control and ownership of businesses organized in one or more corporations. […] M&A contracts serve a typical set of goals, some common to other kinds of transactions, some distinct to M&A. They are not “contracts of adhesion” 3 – while full of “boilerplate,” are negotiated and at least partly tailored to a specific deal in a “bespoke” fashion by specialists. M&A contracts are shaped by regulation of M&A, by corporate law, finance, accounting and the business environment, and by fundamental economics of corporations, especially trade-offs between control and liquidity that influence patterns of ownership. As a result, M&A contracts fall into distinct types, with standard sets of provisions, while varying substantially within type, by country, and over time.” COATES, John C. M&A Contracts: Purposes, Types, Regulation, and Patterns of Practice. In Harvard John M. Olin Discussion Paper Series, n. 825, 2015. Disponível em: <https://dash.harvard.edu/handle/1/17743076>. Acesso em setembro 2018. “[…] Mergers and acquisitions (M&A) consist of deliberate transfers of control and ownership of businesses organized in one or more corporations. […] M&A contracts serve a typical set of goals, some common to other kinds of transactions, some distinct to M&A. They are not “contracts of adhesion” 3 – while full of “boilerplate,” are negotiated and at least partly tailored to a specific deal in a “bespoke” fashion by specialists. M&A contracts are shaped by regulation of M&A, by corporate law, finance, accounting and the business environment, and by fundamental economics of corporations, especially trade-offs between control and liquidity that influence patterns of ownership. As a result, M&A contracts fall into distinct types, with standard sets of provisions, while varying substantially within type, by country, and over time.” COATES, John C. M&A Contracts: Purposes, Types, Regulation, and Patterns of Practice. In Harvard John M. Olin Discussion Paper Series, n. 825, 2015. Available in: <https://dash.harvard.edu/handle/1/17743076>. Access in September 2018.

² Abbreviation that means income before net financial expenses, income and social contribution taxes, depreciation and amortization.