M&A Due Diligence from a Buyer’s Perspective: A CPA’s Guide for Ontario Business Acquisitions
M&A Due Diligence from a Buyer’s Perspective: A CPA’s Guide for Ontario Business Acquisitions
By Bader A. Chowdry, CPA, CA, LPA | Insight Accounting CPA Professional Corporation
Acquiring a business is one of the most significant financial decisions an entrepreneur or investor can make. Whether you’re expanding your existing Mississauga-based company through acquisition or purchasing your first business, thorough due diligence is the difference between a strategic triumph and a costly mistake.
At Insight Accounting CPA, we’ve guided numerous Ontario-based buyers through the complexities of mergers and acquisitions. This comprehensive guide outlines the essential due diligence steps from a buyer’s perspective, helping you protect your investment and position the acquired business for future growth.
Understanding the Due Diligence Framework
Due diligence is the systematic investigation of a target company’s financial, operational, legal, and tax position before completing an acquisition. The process typically spans 30 to 90 days, depending on the transaction size and complexity.
Phase 1: Preliminary Financial Review
Before committing significant resources to a full due diligence process, buyers should conduct a preliminary financial assessment:
Historical Financial Performance
- Review the last three to five years of financial statements (income statements, balance sheets, cash flow statements)
- Analyze revenue trends, seasonality, and growth patterns
- Calculate key performance indicators: gross margins, operating margins, EBITDA margins
- Identify any significant fluctuations or anomalies requiring explanation
- Assess the quality of financial reporting (GAAP/ASPE compliance, audit history)
- Owner compensation that’s above or below market rates
- Related-party transactions that won’t continue post-acquisition
- Non-recurring revenues or expenses (one-time contracts, lawsuit settlements, asset sales)
- Discretionary expenses (personal vehicles, non-essential travel, family members on payroll)
- Non-operating income or expenses
- Verification of T2 corporate income tax filings for the past seven years
- Confirmation of instalment payments and remittance compliance
- Review of notices of assessment and reassessment from CRA
- Assessment of tax loss carryforwards and their availability post-acquisition
- Analysis of scientific research and experimental development (SR&ED) claims, if applicable
- Review of GST/HST registration, collection, and remittance practices
- Verification of source deduction remittances (income tax, CPP, EI)
- Confirmation of T4 and T5 filings for all employees and contractors
- Assessment of WSIB compliance and any outstanding assessments
- Review of PST/QST obligations for businesses operating in multiple provinces
- Allow buyers to “step up” the tax basis of acquired assets
- Generally avoid assuming the seller’s tax liabilities
- May trigger recapture or capital gains for the seller
- Enable allocation of purchase price among asset classes for optimal depreciation
- Result in acquisition of the company’s tax history (both benefits and risks)
- Preserve existing tax attributes (loss carryforwards, tax pools)
- May qualify for lifetime capital gains exemption if acquiring shares of a qualified small business corporation
- Require more extensive tax due diligence to identify hidden exposures
- Analyze the customer roster: Is revenue concentrated among a few large clients?
- Review customer contracts for term, renewal provisions, and change-of-control clauses
- Assess customer retention rates and lifetime value metrics
- Understand the sales cycle and pipeline health
- Identify critical suppliers and their terms
- Assess supply chain risks and concentration
- Review key contracts for exclusivity requirements or minimum purchase commitments
- Evaluate pricing trends and input cost pressures
- Review organizational structure and key personnel
- Assess compensation relative to market rates
- Identify “key person” dependencies
- Understand union relationships and collective agreement terms
- Review employment agreements for change-of-control provisions
- Inventory software licenses and IT infrastructure
- Assess cybersecurity posture and data protection practices
- Review system documentation and backup procedures
- Identify technical debt or obsolete systems requiring replacement
- Articles of incorporation and bylaws
- Minute books and shareholder registers
- Shareholder agreements and unanimous shareholder agreements
- Options, warrants, or convertible securities
- Real estate leases and facility agreements
- Financing agreements and debt covenants
- License and intellectual property agreements
- Joint venture or partnership agreements
- Industry-specific licenses and permits
- Environmental compliance assessments
- Privacy and data protection compliance (PIPEDA)
- Anti-corruption and fraud prevention measures
- Aging of accounts receivable and assessment of collectability
- Inventory valuation methodologies and obsolescence
- Prepaid expenses requiring adjustment
- Accrued liabilities and their adequacy
- Seasonal working capital requirements
- Outstanding bank loans and credit facilities
- Capital lease obligations
- Outstanding letters of credit or guarantees
- Unrecorded obligations (legal claims, warranty exposures)
- Related-party loans and advances
- Convert EBITDA to free cash flow (account for working capital needs, capex, taxes)
- Identify deferred maintenance or capital investment requirements
- Assess growth capital needs for the business plan
- Evaluate dividend or distribution capacity post-acquisition
- Revenue recognition that accelerates income inappropriately
- Aggressive capitalization of expenses that should be expensed
- Related-party transactions at non-arm’s length terms
- Unusual or unexplained journal entries near period ends
- Significant differences between management reports and financial statements
- Unfiled or late tax returns
- Disputes with tax authorities
- Aggressive tax positions without proper documentation
- Worker misclassification (employees treated as contractors)
- Unremitted source deductions or GST/HST
- Concentration risk (customers, vendors, key employees)
- Declining revenue or margins without clear explanation
- Material adverse changes between signing and closing
- Incomplete or missing documentation
- Resistance from sellers to provide information
- Locked Box: Fixed price based on a historical balance sheet date, with limited adjustments
- Completion Accounts: Price adjustment based on actual closing working capital
- Earnouts: Portion of purchase price contingent on future performance targets
- Representations and warranties insurance
- Indemnification provisions with caps and baskets
- Escrow arrangements for holdback funds
- Material adverse change (MAC) clauses
- Financial systems integration and reporting harmonization
- Tax election filings and compliance continuity
- Working capital optimization opportunities
- Cost synergy realization
- Revenue enhancement initiatives
Quality of Earnings Analysis
The income statement presented by sellers often requires normalization to reflect true earning capacity. Common adjustments include:
A proper quality of earnings analysis reveals the sustainable cash flow the business will generate under new ownership.
Phase 2: Tax Due Diligence
Tax exposures represent some of the most significant hidden liabilities in business acquisitions. Our tax specialists at Insight Accounting CPA recommend a comprehensive review of:
Corporate Tax Compliance
GST/HST and Payroll Compliance
Transaction Structure Implications
The acquisition structurewhether an asset purchase or share purchasehas profound tax consequences:
*Asset Purchases:*
*Share Purchases:*
Phase 3: Operational and Commercial Due Diligence
Beyond the numbers, successful acquisitions require deep understanding of how the business actually operates:
Customer and Revenue Concentration
Vendor and Supply Chain Relationships
Employee and Management Assessment
Technology and Systems
Phase 4: Legal and Regulatory Compliance
While legal due diligence is typically led by your M&A lawyer, coordination with your CPA ensures comprehensive coverage:
Corporate Records and Governance
Material Contracts
Regulatory Compliance
Financial Analysis Deep Dive
Working Capital Analysis
Working capital represents a frequent source of post-closing disputes. A detailed analysis should include:
Define working capital targets clearly in the purchase agreement to avoid disputes.
Debt and Obligations
Complete visibility into the company’s indebtedness is essential:
Cash Flow and Capital Requirements
Understanding the true cash flow profile prevents unpleasant surprises:
Red Flags and Deal Breakers
Through hundreds of due diligence engagements, we’ve identified patterns that signal significant risk:
Accounting Red Flags
Tax Red Flags
Operational Red Flags
Structuring the Deal for Success
Purchase Price Mechanisms
Consider these approaches to align incentives and share risk:
Risk Allocation Tools**
Post-Acquisition Integration Planning
Due diligence insights should inform your 100-day integration plan:
Conclusion
Thorough due diligence is not merely a defensive exerciseit’s the foundation for successful acquisition and post-merger integration. The insights gained during due diligence inform not only whether to proceed with the transaction but also how to structure it, price it, and integrate the acquired business.
At Insight Accounting CPA, we provide comprehensive M&A due diligence services for buyers across Ontario. Our approach combines technical accounting expertise, deep tax knowledge, and practical business understanding to deliver insights that protect your investment and position you for success.
Whether you’re acquiring a $500,000 service business or a $5 million manufacturing operation, our team ensures you enter the transaction with eyes wide open and a clear roadmap for value creation.
Ready to explore an acquisition? Contact Insight Accounting CPA at (905) 270-1873 for expert M&A due diligence support.
*About the Author: Bader A. Chowdry, CPA, CA, LPA is the Managing Director of Insight Accounting CPA Professional Corporation, serving businesses across Mississauga, the GTA, and Ontario with Accounting Intelligence™where traditional expertise meets innovative advisory.*
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