Why Due Diligence?

Acquisition deals can be quite costly and most complicated given the number of factors to be considered. The acquisition costs should be separated from the purchase price although close or equivalent. Depending on the scope and magnitude of the deal, acquisition costs include among others direct costs such as fees for due diligence services, accountants, attorneys, and investment bankers. Also, they can include indirect costs such as time, finance costs and debt insurance cost. The value of a proper quality due diligence process on the target(business) is very important and sometimes overlooked. A common challenge with mergers and acquisitions is getting into a business agreement that looks lucrative and not aware of some material facts about the target in question. Fuel service stations are often acquired by entrepreneurs with limited knowledge of the industry who obtain funding to buy service stations at inflated prices that afterwards do not generate the cash required to sustain operations and pay back the funding. On many occasions this result in another bad acquisition deal. The general concurrence is that conducting a holistic due diligence process before committing into a business transaction can substantially increase the chances of succeeding during the transaction and beyond. This process will reveal any hidden material information about the deal and give both the buyer and a seller a great sense of comfort and knowing that all facts about the deal are correct.
Here are some of the key factors to consider when acquiring fuel service station or any business for that matter.

1.Environment
It is critically important to fully understand the petroleum industry in which the service station operates. This includes knowing the value chain in its entirety as well as the opportunities to exploit. These are mainly external factors most of which a potential investor / buyer does not have control over. Overlooking them can be detrimental towards overall strategy of the target. Specific factors such as regulations, Oil company policies, politics, and state of the economy in which the business(target) reside can be a deal breaker. Also, factors such as growing population, massive infrastructure around the area are positive indicators to be considered in the decision making. This calls for a proper “homework” about the target as well as the industry in general. This will shed light in setting the strategy and planning should you decide to go ahead and acquire the target service station. Executed properly, from this exercise there are points to take to the negotiation table.

2.Financial
At the centre of every acquisition are the returns and other benefits such synergies that comes with it. At this point the current and future financial state are the target insights and integrated analysis to drive maximum deal value. If executed properly this gives both parties involved a piece of mind about the deal, especially the buyer. This involves a thorough investigation and robust financial analysis of financial statements presented by the seller. The use of previous financial statements and cash flow projections is key in determining the true market value of business. This due process is there to bring to light any material financial factors that may have been overlooked prior. To ascertain the viability and the ongoing concern of the target, Summary of the target’s inventory costing system and related procedures and policies must be reviewed. Summary of all material capital expenditure projects and those planned in the next 12 months should also be reviewed.

3.Operation and Human Capital
In a case of a fuel service station, it is important to affirm that equipment such as pumps, tanks and other assets are at optimal operation. This exercise will help identify what needs to be repaired and what needs a total replacement and the costs thereof. This is important in that good state of assets or equipment ensures smooth operation of the business which directly translate into revenue generation making it instrumental in the overall evaluation of the target business. Employees are key to the smooth operation of the business. Reviewing the employee contracts, competence, training levels as well as the remuneration structure in place will assist in ascertaining how well can the business survive a change in ownership. Sound employee policies and training programs ensure that the operation of the business do not suffer. The operational and human capital structure of the target also need a fair examination as far as due diligence process is concerned. The process involves amongst others a comprehensive review of the staff list, contractors, and executives. This is done to better understand the skill set and the remuneration structure in relation to any potential recruitment or retrenchments.

4.Environmental, Health and Safety (EH&S)
This part of the due diligence process relates to assessing the general compliance requirements for the industry that the target operates in. For instance, a fuel service station is expected to strictly comply with the regulations regarding generation, treatment, storage, and disposition of hazardous substances. Non-compliance may dent the reputation of the business and strain the relations with the general community it operates in. This may further lead to litigation, penalties, and further deterioration of the business financial and reputational value. These aspects maybe overlooked but contribute massively to the goodwill which arise during the sale of the business. It is therefore necessary to cover issues such as Health and Safety (EH&S) as part of the service station due diligence checklist. This includes copies of any material correspondence with any environmental regulatory agencies. A comprehensive description of any existing ground or underground storage tanks. All investigations, citations, or notices of violation related to employee health and human services.

“All that glitters is not gold”, an acquisition deal may look lucrative and sensible in the eye, but it may not necessarily be valuable or match the asking price. A regrettable position for either the buyer or the seller is to be at the wrong end of the acquisition deal owing to a poor or no due diligence process in place. This process is critical as it gives an opportunity to examine and evaluate the deal in its entirety and bring about transparency.

Outflow Petroleum Insights is well equipped to perform a due diligence process that will help you and your team arrive at the right investment decision.


References
1. https://corporatefinanceinstitute.com/resources/knowledge/finance/acquisition-cost