The ink is dry, the deal is closed, and the integration roadmap is underway. But for many acquirers, the honeymoon phase of a merger or acquisition ends abruptly when post-closing financials begin to diverge from expectations. EBITDA projections fall short, cost structures balloon, and the promised synergies seem more like mirages. What went wrong?
The Pre-Closing Performance Illusion
It’s well known that between 70% and 90% of mergers and acquisitions fail to deliver their intended value. That’s a staggering figure, especially considering the time, money, and strategic energy poured into these deals. We’ve all heard the usual culprits: poor post-merger integration, cultural clashes, and overestimated synergies are frequently cited.
But what if there are other reasons—less discussed but equally damaging—that contribute to deal failure? What if the impression provided by the target company before the deal was simply false? What if the bride was made to look far more appealing than she actually was?
One of the most overlooked risks in M&A transactions is the manipulation of pre-closing financial optics. In the race to present a lean, profitable target, sellers may engage in subtle—or not so subtle—adjustments to operational processes and financial reporting. These tactics can significantly distort the perceived health of the business, leaving buyers with a post-closing hangover.
1. Adjusting Operative Processes
A common and often effective strategy involves tweaking operational behaviors in the financial periods leading up to closing. These adjustments aren’t necessarily fraudulent, but they can be misleading:
- Cost Suppression: High-cost processes are scaled back or paused, giving the illusion of improved margins.
- Investment Freeze: Capital expenditures are halted, temporarily boosting free cash flow but potentially harming long-term growth.
- Revenue Acceleration: Future or uncertain revenues are recognized early, inflating top-line performance.
- Provision Releases: Existing reserves are dissolved, artificially enhancing EBITDA.
These maneuvers can make the business appear more efficient and profitable than it truly is, especially when viewed through the – sometimes narrow – lens of a due diligence snapshot.
2. Adjusting Operative Numbers
A more blatant tactic involves manual manipulation of financial data during the reporting process. These adjustments are often directed by management and executed outside formal accounting systems:
- Manual Reporting Tweaks: Financial figures are altered in reports prepared specifically for the due diligence team, bypassing internal controls.
- Selective Disclosure: Reports may omit unfavorable trends or inconsistencies, painting a rosier picture than reality warrants.
Crucially, the third-party firm conducting financial due diligence is typically not responsible for verifying the congruence between reported figures and underlying accounting data. Nor are they tasked with assessing whether recent operational changes were strategic or merely cosmetic.
The Post-Closing Reality Check
Once the deal closes and the acquiring team gains full access to systems and operations, discrepancies begin to surface:
- EBITDA falls short of projections
- Cost structures revert to historical norms
- Deferred investments demand immediate attention
- Revenue recognition practices raise compliance concerns
These surprises can erode deal value, strain integration efforts, and even trigger legal disputes.
Mitigating the Risk
To avoid post-M&A headaches, acquirers must go beyond surface-level due diligence:
- Demand System-Level Data: Insist on access to raw accounting data, not just curated reports.
- Scrutinize Operational Trends: Compare current processes with historical norms to detect sudden/recent shifts.
- Challenge Revenue Timing: Investigate whether revenue recognition aligns with contractual and delivery realities.
- Engage Forensic Experts: Consider involving specialists who can detect manipulation or aggressive accounting practices.
Post-closing, forensic experts can help investigate and establish the facts—through communication analysis, forensic accounting reviews and targeted interviews—and can work jointly with legal counsel to support the renegotiation of damage claims against the seller.
