The Importance of Strong Due Diligence in Tribal Acquisitions

As more Tribal Nations use Economic Development Corporations (“EDC’s”) to take on larger and more sophisticated investments, it is necessary to develop an equally sophisticated due diligence process.  This process must go beyond simply investigating the transaction and expand to seek a thorough understanding of the operations and infrastructure of the Company as well as the impact of any transition with ownership and/or leadership.

A company’s value is based on its ability to sustain and improve cash flows while managing business risks.  Ownership and leadership transitions create risk to the company and its cash flow.  Crafting a due diligence process that helps the Tribe understand the factors in the business that impact cash flow, stability and growth opportunities (and how a transaction would affect these) will help protect the Tribe and increase the likelihood of a successful acquisition.

Why is due diligence so important?

Due diligence is a process for doing a thorough investigation to better understand the investment and identify potential risks and opportunities while validating that the purchase price will allow the new entity to meet the required returns.  For the most part, due diligence seeks to accomplish three things:

1. Validate

First and foremost, due diligence is there to verify that the information provided by the seller is truthful and correct.  This includes the financial statements (or any adjustments thereto), contracts, legal documents, operations of the company, or the legal standing of the company.  This part of the due diligence process verifies the basis for the purchase price.

2. Understand Risks

Second, due diligence should be used to understand, assess and qualify the risks associated with the investment opportunity.  Some examples of potential risks to examine are:

  • Will an ownership change have an impact on the ability of the company to perform as it has in the past?
  • Who are the key personnel who understand and can manage the operations on a day to day basis?
  • What is the risk of losing key staff with a change in ownership?
  • Does the remaining management and/or ownership share the EDC’s vision for the company moving forward?
  • How vital is the company to its customer base?  How strong is the supply base?
  • What will be the capitalization requirements for the company at closing and into the foreseeable future?

3. Prepare for Transition

Third, due diligence helps develop a plan for the transition, or post-merger integration, of the company into the Tribal EDC’s portfolio.  Some key things to consider include:

  • Is it possible to mitigate or eliminate any of the risks identified during due diligence with the transaction closing and transition?
  • What legal jurisdiction and UCC code will the new entity operate in?
  • What are the tax implications of these decisions?
  • How will key strategic decisions be made for the new entity once they are under the management of the EDC’s holding company?
  • What changes will need to be made to the new entity’s operating agreement, HR policies and financial systems in order to keep it in compliance with the EDC’s requirements?  This is especially important for Federal 8(a) contracting companies.

The importance of a strategic plan:

While the steps mentioned above are extremely important, they become nearly meaningless if the EDC does not have a thorough strategic plan to guide the acquisition process.  A strategic plan provides direction and structure to the complicated task of performing due diligence by:

  • Outlining the investment criteria (i.e. – controlling interest requirements, industry or sectors to be sought out or avoided, minimum expected  returns, etc).
  • Alignment of key stakeholders and set the expectations of any investment (does the due diligence show that the projected future performance meets the expectations set by the strategic plan?).
  • Define the priorities of the due diligence investigation (emphasis on financial, operational, leadership, future opportunities, historical results, etc).
  • Define how due diligence will be coordinated and who is involved in the approval process.

Any investment, especially a direct investment in an operating company, is an exciting but complicated process.  Due diligence is a key factor to provide an investment the best chance of succeeding and providing positive returns.  Having a strong due diligence process, transition plan, strategic plan and qualified advisors in place before an acquisition will help ensure an EDC obtains all necessary information to make a well-informed decision.

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