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Due Diligence Fundamentals

Due Diligence Fundamentals. November 6, 2011. Illustrative Transaction Process. PHASE IV Negotiations. PHASE V Transition Optimization. PHASE I Strategic Analysis. PHASE II Opportunity Analysis. PHASE III Transaction Development. NEEDS & RISK ASSESSMENT. SELECTION OF TARGET

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Due Diligence Fundamentals

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  1. Due Diligence Fundamentals November 6, 2011

  2. Illustrative Transaction Process PHASE IV Negotiations PHASE V Transition Optimization PHASE I Strategic Analysis PHASE II Opportunity Analysis PHASE III Transaction Development NEEDS & RISK ASSESSMENT SELECTION OF TARGET COMPANY DUE DILIGENCE INTEGRATION NEGOTIATION

  3. Risk and Needs Analysis Target Selection Analysis and Identification Determination of Deal Drivers Strategic Direction IDENTIFICATION OF RISKS AND NEEDS Due Diligence Strategic Target External Growth: Acquisition • EBITDA • Cash Flow • Market Share • Facilities • Human Capital • Etc. • COMPETITION • PRICE PRESSURE • INNOVATION • RETURN ON INVESTMENT • EMPLOYEE TURNOVER

  4. Effective Due Diligence: Focus on Deal Drivers EBITDA ETC. CASH FLOWS MARKET SHARE INTELLECTUAL PROPERTY Deal Drivers Accounting Policies Capital Expenditure Outstanding Litigation HR Compliment Working Capital Seasonality Pro-forma Adjustments Forecasts & Budgets Cash Burn Quality of Earnings Revenues & Operating margins Stand Alone costs Related Party Transactions Balance Sheet Analysis Contingencies & Commitments Contracts and Obligations Employee Benefit Plans Due Diligence Focus Areas Due Diligence Action Plan Customized Financial Due Diligence Plan

  5. Due Diligence and Transaction Value Due Due diligence procedures are focused on matters that could impact purchase price and building in appropriate protections for your purchase agreement. • Quality of earnings • Price vs. volume vs. mix changes • Givebacks and rebates • Unsupportable platform volumes • Loss of key customers • Productivity assumptions • Effect of foreign exchange fluctuations • Commodity price exposure • Tooling gross margin Revenue and Margin Purchase Price + - + - Non- Operating Assets & Liabilities + - Working Capital Adjustments Target’s Normalized EBITDA Multiple Tax • Cash flow analysis • Deferred spending in anticipation of transaction • Growth versus maintenance categorization • Misalignment with revenue growth • Customer tooling X Maintenance/ Capex Requirements • Net debt /Insurance due diligence • Guarantees • Contingent liabilities • Financial debt • Derivatives • Incomplete restructuring • Unfunded pension and OPEB • Environmental remediation • Inadequate insurance • Trapped cash • Redundant assets • Cash flow analysis • Normalized working capital investment • Recovery of AR • Inventory valuation • Completeness of AP and accruals • Tax due diligence • Income tax obligations • Available attributes Enterprise Value • Quality of earnings/IT & Insurance due diligence • Unrecorded audit adjustments • GAAP differences • Fixed vs. variable cost structure • Non-recurring/non-cash transactions • Unsupported cost reduction assumptions • Temporary wage freezes • Compensation & benefits structure Operating and G&A Costs Acquisition Accounting

  6. EBITDA • Equalizes the differing choices in capital structure • E - Earnings • B - Before • I – Interest • T - Income Tax • D – Depreciation • A – Amortization • Adjusted EBITDA • Attempts to estimate stand alone sustainable operating cash flow • Accounting issues • One-time items • Pro-forma adjustments

  7. Quality of Earnings: Impact to Purchase price Valuation build-up for target 4 Prioritized Synergy Value 3 2 1 Adjusted EBITDA before synergies Proforma Adjustments Cash From Operations • Constant currency • Plant closures • Customer attrition • Shareholder compensation adjustments to market GAAP Adjustments • Gain on sale of fixed assets • Cash pension • Unusual warranty claims • Reversal of provision release Reported EBITDA • Capitalized costs • Revenue recognition • Incomplete expenses accruals

  8. Non-Operating Assets and Liabilities • Net debt /Insurance due diligence • Guarantees • Contingent liabilities • Financial debt • Derivatives • Incomplete restructuring • Unfunded pension and OPEB • Environmental remediation • Inadequate insurance • Trapped cash • Redundant assets

  9. Tax Issues and Considerations • Payroll taxes, property taxes, VAT, HST, GST, Duties etc. are operating costs • Impact EBITDA • Evaluate liabilities • Directors can have personal liability • Understand tax attributes • Operating losses, capital losses, tax basis of depreciable assets • Impact of prior year’s tax filings (exposures) • Establish the foundation for tax structuring

  10. Working Capital • Valuation of assets and liabilities • Seasonality of working capital and operating cash flows • Appropriateness of reserves • “Normal” level of working capital • Cash flow impact of realization of assets and liabilities • Commitments and contingencies • Accounting policy for complex assets and liabilities (i.e., derivatives, funded obligations, etc.)

  11. Financial Due Diligence:Value Proposition • Optimize Pricing • Understand the target’s business and risks • Alignment of transaction needs • Find the skeletons • Refine the deal • Development of integration plan • Avoid a bad deal or Make a Good Deal Better!

  12. Rohit Prajapati, CA, Macc, BA Associate Partner, Transaction Advisory Services, Transaction Support 416-943-2082

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