Uncovering blind spots to boost M&A outcomes

How forensic due diligence can help safeguard your assets

While Canadian organizations are quick to take care of the necessary financial due diligence when they expand through mergers and acquisitions (M&A), it’s increasingly important to pay attention to a broader set of risks, including acts of fraud and corruption by the target company.

According to PwC’s 2018 CEO Survey, 44% of Canadian CEOs see M&A as an important strategy for growth. As they become more aggressive in making deals, Canadian companies can find themselves racing to get agreements signed in new and high-risk markets where acquisition targets may operate by unwritten and different rules than organizations in Canada follow.

Before, and even briefly after a deal is signed, dealmakers have the opportunity to add to their M&A checklist by undergoing thorough forensic due diligence to identify fraud, corruption or unethical business practices that aren’t often found in traditional financial diligence.

The risks of not undergoing a thorough M&A due diligence process can be significant: erosion of deal value, legal and regulatory sanctions and reputational damage, to name just a few.

It’s important to minimize those risks by looking deeper into the target company’s operations to examine its internal controls, identify and investigate suspicious payments and transactions and assess compliance. But as our 2018 Global Economic Crime and Fraud Survey found, Canadian businesses perform less forensic due diligence during the acquisition process than their global counterparts. So there’s a significant opportunity for dealmakers to ensure the deal is a success and get even more out of their M&A activities without unduly slowing the process down.

Does your organization perform any of the following additional due diligence as part of your acquisition process?

Behind the deal

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What to look for

When you’re buying a company, its business partners can become your business partners. So it’s important for dealmakers to uncover activities or practices that may cause legal, financial or reputational problems in the future. Issues and areas to investigate include:

  • the target company’s dealings with governments, vendors and clients
  • compliance with internal rules
  • whistleblower reports
  • the target company’s bribery and corruption controls
  • local tendering and recordation practices
  • the target company’s subsidiaries
  • payment practices and other third-party transactions

A growing issue

A recent upswing in global enforcement of anti-fraud and anti-corruption regulations makes it even more important for Canadian businesses to step up their efforts to detect and deter issues like fraud and corruption. This includes issues that may come up in the M&A context.

Governments around the world, including those in emerging-market countries like Brazil, are stepping up enforcement actions, while anti-corruption authorities are increasingly co-operating across borders. If you’re a Canadian organization buying a company that does business internationally, for example, you may find yourself under the lens of US or British regulators and will need to consider both domestic and foreign regulatory requirements.

The environment is also shifting in Canada. Recent legal changes allow the federal government to pursue companies through the use of deferred prosecution agreements (DPAs) under its new remediation agreement regime (RAR). These agreements make it easier for the government to settle cases by allowing companies to avoid a criminal conviction in exchange for paying fines, making restitution and promising to remediate existing corruption issues.

This new enforcement tool creates even more incentives for companies to dig deeper before signing a deal and to co-operate with regulators when issues arise. Regulators won’t accept ignorance as an excuse, and any purchaser should ensure it has the resources necessary to assess a target company’s dealings with governments, vendors and clients.

Opportunities for dealmakers

For dealmakers, taking a deeper look at an acquisition target offers a number of advantages:

1. Bring greater value to the deal

company’s activities may hinder the deal process. But the process doesn’t have to delay or stop the deal. Rather, it becomes a valuable intelligence-gathering effort that can ultimately inform strategic business decisions.

Equipped with better information, you may be able to renegotiate the valuation of a deal, carve out certain operations or personnel or incorporate safeguards against the risks associated with historical transactions. At the very least, the process allows you to stop improper practices by, for example, terminating a risky third party.

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2. Uncover the blind spots

Illegal or unethical behaviour by company personnel isn’t always obvious to someone looking into a business at the outset of M&A discussions. Inappropriate payment or business practices can be hidden in large amounts of data or through seemingly normal third-party transactions that are, in fact, kickbacks or payments to offshore accounts.

Data analytics and modelling can quickly sift through vast amounts of information to find those hidden problems. Specialized analytical software can help to identify high-risk transactions and test them to see whether they comply with the acquisition target’s own internal rules and broader anti-corruption and anti-bribery regulations.

Dealmakers also need to look outside the data room. This means having people on the ground, before you sign the deal, who understand regional business practices, law enforcement, language and culture and can identify dealings that may lead to trouble and have an impact on ultimate deal value.

Corruption may involve vendors or the target companies’ subsidiaries, and it often centres on smaller amounts of money that slip under the radar of financial due diligence. But it’s important to realize that enforcement officials don’t distinguish between financially material and non-material amounts when pursuing bribery and corruption.

Even efforts to be a good corporate citizen can present a problem, as in the case of donations by the target company to organizations linked to a government minister. A company doesn’t necessarily have to be selling products or services to the government to be at risk. Other activities, such as applying for government licences and permits, can also create problems.

A forensics diligence team also typically interviews different people and looks at different documents than those performing financial due diligence may consider. For instance, it will seek whistleblower reports and documents detailing a company’s bribery and corruption controls, investigate local tendering and recordation practices and talk to officials such as the chief legal and compliance officer and foreign sales managers.

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3. Seal a successful deal

Following the closure of a deal, the acquiring party has about six months to uncover and report illicit activity if it’s going to avoid successor liability. A post-acquisition forensics review can be helpful, but a pre-acquisition one is even better.

Companies that fail to conduct necessary forensic due diligence can find themselves paying a heavy price for what they didn’t know before signing the deal. In one case, a company lost $900 million in deal value after learning that much of the revenue the target organization was reporting involved corrupt practices.

In a second case, the purchaser ended up spending more money than the acquisition price itself to deal with unexpected corruption and bribery issues discovered by management after closing the deal.

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A better outcome

Global M&A activity remains strong, and Canadian dealmakers are eager to be a part of it. While there are always risks, you do have options for minimizing or avoiding them, without slowing the deal down. Those dealmakers that address the hidden risks ahead of time will be well positioned to achieve their M&A goals and realize full deal value.

Contact us

Frederic Miller
Managing Director, Forensic Services, PwC Canada
Tel: +1 416 814 5886
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