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Due diligence on
public companies
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Recently theres been a great deal of press around the level

of due diligence that should be performed on an acquisition
of a public company. As deal activity continues to return to
the North American marketplace, your Audit Committee
Connect team sat down with Dominic Ricketts, National
Leader of our Transaction Services Practice to talk about
the best practices boards should be considering when it
comes to performing due diligence on a public company.
The following is only a summary. Please contact Dominic
or your local partner for a deeper discussion.

Neil Manji
Leader, Audit
Committee Connect
+1 416 687 8130
neil.manji@ca.pwc.com

Dominic Ricketts
Leader, National
Transaction Services
+1 416 687 8408
dominic.ricketts@
ca.pwc.com

Summary
1. What are some of the common
risks management and boards should
consider in an acquisition?
Many companies believe that acquisition risk primarily pertains
to execution or integration. Another somewhat overlooked
factor in deal failure is overpaying for the target business in the
first place, often because the acquirers evaluation of the future
profitability of the business was too optimistic or the Buyer did
not understand recent historical performance.
Another risk that comes with an acquisition is information and
access often being limited due to regulatory requirements, other
competitive constraints or seller negotiating tactics. Concerns
regarding leaks and confidentiality can also lead to significant
time pressure.
Management bias or deal fever can also get in the way. While a
target might seem like a great strategic fit, the deal terms may
not enhance shareholder value. Boards should be alert that at
times there may be pressure to make the numbers work, yet the
diligence findings may not readily support that approach.

2. What are the unique risks in

acquiring a public company?
A common misconception is that public deals are less risky than
private transactions.
In public deals, control premiums are often paid which are
significantly higher than the prior trading price of the stock. Much
of the value is dependent on post-closing cost reductions, revenue
synergies and other merger related benefits. To the extent these
synergies are built into the price paid to selling shareholders, the
potential returns to the acquirer are lower. In justifying these
seller premiums, its important to assess the potential interaction,
how much is built into the price paid and the relative confidence
level of achieving the desired combined effect.
Time and information limitations and access restrictions are
common in deals overall and generally even more restrictive in
public transactions. However, public information alone is not
sufficient for the kind of diligence that control investors must
perform. Public companies are generally larger, employ complex
legal structures and business transactions and have more
nuanced disclosures. While results may be compliant with GAAP,
financial statements and disclosures are not aimed at revealing
underlying revenue and earnings sustainability, which is critical
to assessing the value of a business being acquired. Control
investors also need insight into forecasts that extend beyond
public disclosures, and must assess synergies, management
quality and other areas.
Also in public deals, there are no seller representations and
warranties that survive closing, nor are there indemnification
escrows and therefore, no easy remedy if issues are uncovered
later. Greater due diligence is required given the limited
protections.

3. Audited financial
statements and
acquisition due diligence
how do they link?
Audited financial statements are based
on GAAP and history, while deal value
is based on cash flows and the future.
As such, assessing deal value requires
a deeper evaluation of the underlying
value drivers that can only be assessed
at more granular levels of information.
Additionally, audited financial statements
dont cover subsequent results which can
be the most important element for the
baseline forecast.
Audited financial statements are also
based on judgments and estimates
involving complex transactions.
Understanding those judgments and
estimates is not only a key part of
understanding historical business
performance, it also informs ones
evaluation of future cash flows and
purchase price. That understanding,
however, cannot be obtained just by
reading the financial statements alone.
Value also comes from synergies which
require more detailed operational and
financial insight.

4. How much due

diligence is enough?
The key diligence objectives should
include whether the strategy has been
validated and the deal terms and
valuation drivers are supportable from the
buyers perspective. This involves some
judgment regarding risk areas and the
comfort level required to sign off in the
context of the overall transaction.

The risk based assessment should happen

within each functional team financial,
accounting, tax, information technology,
human resources, sales, operations,
research and development, legal etc and
then overall for the entire transaction.
Balancing demands for incremental
information and due diligence against
the deal pressure is often challenging.
However, management should have a
process to ensure satisfaction with the
primary deal drivers and other items
affecting value.
While every deal is different, we believe
minimum standards for diligence should
be established. The standards can be
customized to the requirements of each
deal, but significant gaps from minimum
standards should be communicated to key
decision makers.

Conclusion
In addressing some of the challenges
discussed above, we believe that
management and boards need to
understand and evaluate their deal
process - from target identification,
negotiation, evaluation, closing,
integration and post deal monitoring - to
assessing whether they employ leading
practices. Management and boards should
understand information and access
limitations, along with risk mitigation
plans, in the final approval process.

Top 10 questions directors

should consider regarding
acquisition due diligence
1. To what extent do we have a robust
and industry standard deal process, from
developing a deal pipeline to diligence to
integrating and monitoring success?
2. Whats the acquisition strategy and how
is that linked to our corporate strategy?
3. What level of deal expertise do we have
within our organization and whats our
readiness? What are the gaps?
4. What are our standards for due
diligence in terms of functions involved,
scope and level of detail?
5. What are our criteria and standards for
approving a particular transaction (e.g.
earnings per share, return on investment,
combined targets, integration plan etc)?
6. What has been the performance of past
deals and how is that monitored?
7. Is there a regular process for monitoring
both the base business and synergies, led
by someone independent of the business
leader?
8. Was the diligence objective? What was
the level of access and were there any
restrictions?

Additionally, its important to have an

objective, trusted advisor to perform
robust pre-acquisition due diligence,
including a linkage of the findings to
value and deal terms. Ensuring that an
advisor has the courage to raise issues and
concerns that may be counter to executive
management views is important.

9. How were the diligence findings

incorporated into the deal model, deal
terms and integration plan? How were
risks mitigated?

Sometimes, the best decision is to not

move forward with a transaction.

i. To what extent have all members of the

deal team (internal and external) been
able to voice their opinion?

10. Was the board provided the full

report, and given a chance to ask
questions, or just a summary provided by
management?

ii. Do our advisors have the expertise and

courage to speak against the CEO and
management if necessary?

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