The UK’s decision last year to exit the European Union shocked the business community and left many wondering how their business and growth strategies would be affected.
While the exact outcome of triggering Article 50 is subject to intense speculation in the media, it’s clear that the due diligence process will now need to encompass some additional considerations.
In the majority of due diligence assignments, quality of earnings is a key consideration for the acquirer. This usually involves analysing EBITDA (Earnings before Interest, Taxes, Depreciation and Amortisation) and removing any one-off income or expenditure so that a true picture of the underlying earnings can be identified.
In a post-Brexit environment, it becomes even more critical to understand what adjustments need to be made to EBITDA. For example, the heightened volatility of foreign exchange (forex) movements in comparison to GBP may lead to more extreme forex differences in reported earnings through changes in sales prices, cost of goods sold or on revaluation of financial instruments. Due consideration will need to be given as to how the gains or losses should be treated and whether they mask underlying trends in the business.
It is possible that, in future, a range of EU legislation will no longer apply in the UK and this could result in a higher cost base; for example, labour costs may increase if access to migrant workers is restricted or tariffs / duties are increased.
Further to the financial impact of Brexit, the operational effects will need to be considered. Where the target in a transaction uses a skilled European workforce, has suppliers or customers from outside the UK or is subject to tariffs or trading agreements it will be important to understand what the impact to the business will be if these relationships can no longer operate in the way they have done previously. Suppliers and funders could use Brexit as an opportunity to renegotiate prices when arrangements are up for renewal and therefore it is important that all key contracts are reviewed as part of the due diligence process – this can fall to either the legal or financial due diligence providers. If UK businesses assess EU membership to be a key benefit to their business then they may need to review their corporate structure and group arrangements. It may even prove necessary to set up a subsidiary within the EU and channel their business through that entity.
The risk factors impacting businesses in the post-Brexit world are becoming increasingly diverse and complex - but more worryingly these factors are subject to change. As a consequence, it is imperative that due diligence reports are scoped and agreed by all parties in advance and include a careful assessment of the quality of both current and projected earnings.
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By necessity, this briefing can only provide a short overview and it is essential to seek professional advice before applying the contents of this article. This briefing does not constitute advice nor a recommendation relating to the acquisition or disposal of investments. No responsibility can be taken for any loss arising from action taken or refrained from on the basis of this publication. Details correct at time of writing.
This article was previously published on Smith & Williamson prior to the launch of Evelyn Partners.