During merger and acquisition (M&A) transactions, it’s crucial to use due diligence to decide whether to proceed with the deal and at what price. Although the process isn’t necessarily designed to detect fraud, it can occur during any point of the purchase, from discounting cash flows to undermining past legal troubles. It’s up to both the seller and the buyer to have a mutual understanding and trust that all information is evident before closing the deal.
Below are four key considerations regarding M&A transaction fraud and what you, as a buyer or seller, can do to reduce fraud risk:
- The use of due diligence and proposing an EBITDA adjustment is uncommon, especially when it’s fraud related. This is because buyers of smaller transactions don’t want to be burdened with a lot of testing since they tend to have poor internal controls or loose, inconsistent accounting procedures.
- Financial statement misstatements comprise the majority of frauds that occur during M&A transactions since they involve revenue. On average, financial statement misstatements cause a loss of $1 million per incident due to difficulties in revenue recognition and multiple deliverables to customers.
- Forensic accounting is usually conducted when fraud is either suspected or has been found. This is different than due diligence since due diligence is generally focused on normalized EBITDA and working capital. Forensic accounting is also performed as a separate engagement.
- Having a third party perform due diligence is critical to make sure there isn’t any bias involved during the deal. Companies often try to conduct due diligence internally to save money, but time becomes an issue when a CFO of the buyer has a full-time job and has to perform a full, thorough due diligence. It isn’t realistic and creates more opportunity for error.
These are just a few of the relevant considerations. If you have any questions regarding any of these topics, please let us know.