Due diligence is an Americanism which has infiltrated its way into the English business vocabulary. It is commonly used in the context of Company A buying Company B or Company B’s assets (the latter, incidentally being much the simpler from a due diligence and tax perspective).
All it means is checking that there are no skeletons in the cupboard of the entity you are buying. It is not that complicated (though it can be time-consuming) and it is something that can perfectly feasibly be done by you or your staff. Lawyers and accountants tend to make a bit of a meal of it all and often work to very lengthy and complicated checklists. However, if it is important to you to be absolutely sure if the kettle is on an operating or finance lease, go ahead.
Most of the purely commercial due diligence may well be done by you as the potential acquirer in the early stages of the negotiations where information will gradually be released by the vendor as their confidence level increases. Some other areas may not have been covered in such detail – the main ones being legal, financial and IP related due diligence.
In order to avoid the professional fees running away during the acquisition process I suggest the following:
- Hold off on due diligence until the deal is looking fairly secure. It is actually unlikely that the process will throw up anything which is a deal-breaker. This is far more likely to come from dodgy negotiating tactics throwing a spanner in the works at an advanced stage. By all means get everyone teed up but hold the starting gun. The only possible exception to this is in the IP area. I have come across deals which have foundered because, fairly late on, the IP protection was not as robust as everyone thought. This could take the form of incomplete patent protection, competing patent claims or disputes or even problems with efficacy or toxicity (one now defunct client found major problems in this area by a cursory check on the internet!)
- Do what you can yourself. As you can see from the following link which I have used as an example http://www.meritusventures.com/template_assets/pdf/diligence.pdf the process is not technically complex.
- Meet with the professionals beforehand and work out with them what the real risk areas are. You can then concentrate on the key areas and forget about the kettle.
- Get the professionals to liaise with each other to avoid unnecessary duplication. This is more common than you might think.
- Make sure their report is only a couple of pages long. If it really takes longer than two pages to report the main findings, eyebrows should be raised about the whole deal.
You might want to have a look at any environmental issues, marketing, production, IT to name but a few. But the really important areas are management and organisational compatibility. Many mergers/takeovers do not work well because the new owners get bored with the implementation phase and move onto the next deal. Proper implementation is vital but this sort of detail often gets ignored at the time (a bit like Iraq) and look what happened there. So the bedding in process after the acquisition/merger really is worth taking a bit of time over.
Of course acquisitions take place in the charity and Not-for-profit sector too, particularly nowadays where consolidation is becoming more common as organisations realise they are just too small to fulfil their charitable objectives. The Charity Commission has also produced a very sensible checklist which can be found at http://www.charity-commission.gov.uk/Library/chkduedil.pdf and this could easily be adapted for commercial purposes.
Don’t forget that due diligence can work in both directions. Firstly, you as the potential acquire might well want to check out the acquirer. Do they have the wherewithal to complete the deal? If there is a share/loan stock element will the share hold their value and the loans be repaid? What is their management like? Do you trust them to maximise the chance of any earn-out coming to fruition?
Also, you might well want to get ahead of yourself if a sale is on the cards in the future. Why not do some due diligence on yourself and see what comes up? It could be quite informative. This is particularly so with tech companies where you will be trying to prove there isn’t a problem – which is difficult at the best of times.
Anyway it looks like we are stuck with the “due diligence” terminology along with bottom line, boot-strapping, lines in the sand, elephants in the room, learning curve, squaring the circle, re-inventing the wheel, power lunch, slam dunk, etc. The genie is well and truly out of the bottle with these particular phrases
All you need to know about auditing (but were afraid to ask)
I don’t really know how to make this interesting. The best I can hope for is that you are reading this because you want to know something about financial audits.
Let’s start with a definition. Most of us in the profession know what they mean by an audit in the same way that medics will understand what “Choledocholithiasis” means (gallstones to save you looking it up). But most lay people don’t. Basically it is a fancy name for checking things. You might also come across the word “assurance” which is another fancy word for checking things. It is not what we do when we prepare accounts for a typical SME. SMEs do not usually need an audit unless their sales exceed £6.5m p.a. and, although we have a critical look through the client’s records when we are doing the accounts, we aren’t auditing them.
Auditing can be split into two types – those required by Act of Parliament (statutory) and other audits.
Statutory audits include audits under the Companies Act 2006 when sales are greater than £6.5m p.a. or other exemptions are not satisfied, and under the Charities Act 2011 where income exceeds £500,000. Incidentally, Charities are much more complicated in this regard than Companies. I won’t attempt to set out the requirements but have a look at http://www.charity-commission.gov.uk/Publications/cc15b.aspx if you are interested. These acts don’t dictate what auditors need to do and these are fleshed out in Audit Regulations and Auditing Standards.
Other audits include a whole set of audits including:
- Purely voluntary audits where the entity concerned thinks it would be a good idea;
- Audits imposed by outside investors in investment agreements (which often require a statutory audit;
- Audits required by the Memorandum and Articles of a company (rare except with quite old companies);
- Grant audits from UK/EC grant funders. These audits normally place specific requirements on the auditor to check, broadly speaking, that money has actually been spent on the project being funded and that the expenditure properly relates to the project and the types of expenditure being grant-aided;
- Internal audits where (usually a large organisation) conducts a self-examination of its own internal systems and procedures. It may have its own Internal Audit Department or may use an outside body. The nature of these audits varies widely;
- Audits instigated by HMRC under their statutory powers;
- Independent examinations for charities. These are a sort of hybrid as they are required when a charity has income over £25,000 and there are specific requirements but the examiner’s report is on the lines of “nothing has come to our attention to suggest that………” which is obviously much better from a professional negligence perspective than “these accounts give a true and fair view of……” which statutory audits require.
So what do auditors actually do? In a nutshell they do the following:
- Plan what they are going to do;
- Document the client’s accounting system;
- Check the system operates as documented (not always required);
- Check specific accounting transactions;
- Check the printed accounts agree with the underlying records;
- Check the accounts disclose everything they should.
But, you may say, testing everything is impossible, and you would be right. We get over this in two ways. Firstly we have a concept of materiality which broadly says that you ignore anything small. Secondly, having eliminated the small items, we only check some of the big items. This is called sampling. This cuts down the checking to a manageable size. However it clearly avoids about 99% of the transactions so is highly unlikely to unearth any small irregularities.
Audits are supposed to give (note cautious wording) ”reasonable assurance that the accounts are free from material misstatement… by fraud” but note that this is not a guarantee – more of an aspiration. Clearly this aspiration fell short in the cases of Barlow Clowes, Polly Peck, Enron etc. Realistically, discovering frauds of any size is very rare. I have only ever been on one audit where a fraud was discovered in 35 years of auditing.
Do audits have any real benefits? My own view is that it is not worth having a statutory audit if you don’t need one. This is because the amount of time the auditor spends on “peripheral” matters such as planning and documenting what they do and checking accounts disclosures etc reduces the time available for actually rootling about in the systems and transactions. However, agreeing with the auditor some sort of tailor-made specific report and specific areas to look at could well be helpful, particularly if the emphasis was on efficiency, system improvements and better controls.
Audits are also useful if you are checking a customer’s credit-worthiness. This is something that clients do not do often enough even though it’s very simple. Unfortunately, as most small companies don’t have an audit and don’t even have to file a Profit and Loss account at Companies House – just a Balance Sheet – it’s difficult to get any useful information. But if an audit has been conducted, anything less than a clean audit should raise eyebrows. Watch in particular for paragraphs headed:
- “Basis for Qualified Opinion”,
- “Basis for Adverse Opinion” or “Adverse Opinion on …”
- “Disclaimer of Opinion on….”
- “Qualified Opinion on other matter…..”
- “Emphasis of matter”
1-4 normally mean the auditors think the accounts are wrong. 5 normally means there’s something significant which you need to be aware of (often related to future funding or lack of).
Tax – when the irresistible force meets the immoveable object
Tax – when the irresistible force meets the immoveable object
(or how to succeed before the First Tier Tax Tribunal)
You have been involved in a protracted struggle with HMRC for what seems like an age. You are racking up costs with your accountant and little or no progress seems to have been made. You don’t want to give in because you feel that you are in the right but there seems nowhere left to go.
Why not give the First Tier Tax Tribunal a try? It has a number of advantages for the taxpayer:
• It is free;
• Costs are rarely awarded except in exceptional cases;
• The tribunal is independent;
• It is an informal process and barrister representation is not required;
• The Tribunal approaches matters in a common sense way;
• Any findings of fact by the Tribunal are normally binding so the only avenue of appeal from the Tribunal is on points of law (if there are any);
• It may provide finality quicker than continuing with correspondence and negotiation.
However, those who are not familiar with the process will be at a significant disadvantage when faced with an HMRC presenting officer who deals with the Tribunals on a regular basis. It is important to understand which lines of attack are likely to succeed and, just as importantly, which ones will not.
Here are some of the approaches which will fall on stony ground:
• It is unfair;
• This is my first mistake;
• I didn’t know I had to ……;
• I was only a few days late;
• My accountant/bookkeeper let me down;
• I paid late because I am having cashflow problems at the moment;
• I can’t afford to pay a penalty of this size;
• I promise it won’t happen again;
• We have put processes in place to ensure it won’t re-occur;
• I thought I didn’t need to send it because it was a nil return;
• HMRC have not replied to correspondence and have been generally inefficient;
• I thought I’d submitted it successfully on-line;
• I didn’t know internet payments take 3 days to clear.
Approaches which may well work are too diverse and variable to include in a short article like this but prerequisites for success are:
• Understanding the tax law concerned;
• Assembling a body of supporting evidence;
• Concentrating on the most promising lines of defence;
• Spotting weaknesses in HMRC’s case;
• Presenting the case clearly, logically and forcefully.
Many cases before Tribunals deal with the concept of reasonable excuse. However this is not “reasonable” in the common sense meaning of the word. Instead it is a legal construct which has evolved following a number of decided cases and can be a deceptively tricky area.
So my advice, as an accountant with extensive involvement with the Tribunal system over a number of years, is to bear in mind the possibility of opting for the Tribunal approach. But careful preparation and a professional approach are vital.