Technical Due Diligence – Efficiency and EffEctiveness
The technical due diligence process is intended to give the potential purchaser of an asset an accurate understanding of the state of an asset, so that a good acquisition decision can be made. I have now managed a number of these processes over the last ten years, both as an advisor and as the potential purchaser’s responsible Head of Department and am happy to share some of this experience.
My objective in leading technical due diligence programs is to give the client the information that they need to make a good decision that contributes to the client’s strategic objectives in making that decision.
The first step is to understand and articulate the reason why the potential acquisition supports the business strategy. This strategic fit needs to be well understood by the due diligence team so that the issues and risks identified can be assessed in light of the objectives of the acquisition. For example, technical due diligence on a second-hand aircraft that is to be broken up for scrap is very different to a due diligence to be undertaken on an aircraft that is required to continue operational service. With this strategy information, the team can focus on the aspects that impact resale value of valuable components (such as the condition of the engines) and ignore the issues that may be more relevant if it is necessary to retain the aircraft in service (such as the fatigue life of the fuselage).
Once the objectives are understood by the due diligence team, we then move into the fatal flaws phase. During this phase we work through the key high-risk issues that may prevent the assets from contributing to the business. The questions that we ask during this phase are:
- Can the asset continue to be lawfully operated by the new owner? Are the necessary licences and permits in place, are they transferable and is the plant capable of meeting the relevant conditions and likely new emerging conditions?
- What is the capacity of the asset; or more importantly, what is the capacity of the asset under its normal commercial operating conditions (in the case of a peaking gas turbine in Australia for example, during summer at high temperatures, after auxiliary power is consumed and after transmission (and distribution) loss factors have been applied)?
- What is the variable cost of production (short run marginal costs for power generating assets), how does this compare to variable revenue and is positive cashflow sustainable?
- What is the remaining life? Is there sufficient asset management information available to have an initial indication that the plant can continue to be maintained and operated safely?
- What is the state of the asset’s social licence? Are there community, political or social issues (either legacy or emerging) that might be inconsistent with the client’s values?
At this stage we go back to the client with an initial indication that the asset (subject to detailed due diligence) is likely to (or perhaps will not) support the client’s objectives in making the acquisition, prior to commitment to the full due diligence process (involving a larger, and generally more expensive, group of consultants).
We then progress to the detailed due diligence phase. At this stage the team expands to involve technical specialists in fields such as approvals, contaminated land, workplace health and safety and engineering (with experience in the specific technology being assessed). We work hand in hand with the client’s team (generally including tax, legal and financial advisors). As the due diligence team’s leader, my role in this phase is to keep the team tracking to their objectives, maintaining an understanding of the issues raised and being prepared to address issues with the client (drawing back to the strategic objectives in undertaking the due diligence). As issues are raised, additional study in specific areas are undertaken so that the client has a good understanding of the issued and risks.
Site inspections and clarification meetings are held with the vendor and their advisors. During this process we drill down into the issues and encourage the vendor to provide the information to remove uncertainty in our assessments.
We are then available to advise senior managers, boards and investment committees on what we find and our opinion on risks and issues.