Acquirers are warned that a lack of post-deal communication could cost firms five points of EBITDA in ‘buyer beware’ fraud. This real example shows how better pre/post-acquisition communication could help to prevent losses.
What is Buyer Beware Fraud in M&A?
A buyer beware fraud occurs during the merger and acquisition process. It involves deliberate manipulation of the target company’s accounts. There is often an inflated fictitious turnover, wrongly capitalised expenses and / or concealed financial results. This means the acquirer is not getting access to an accurate picture of what they are buying, and the damage only becomes apparent after the transaction has been completed, when it is too late.
In this case, the Group in question practices extensive vertical integration and frequently buys small businesses. Since this acquisition-driven approach is part of their economic model, the existing managers generally remain in place to ensure continuity and secure the transition, while dividends tend to remain relatively limited.
How Accounting Manipulations Inflate Valuation.
In this particular situation, the manager of the acquired company had stayed on for a very long time and had “dressed up the bride” remarkably well. In concrete terms, he had artificially inflated revenue through simple and well-known mechanisms: issuing fictitious invoices, deferring certain expenses, and recording some costs as capital expenditures rather than operating expenses. By increasing revenue and reducing reported costs, the financial indicators appeared highly attractive.
Because the purchase price was based on EBITDA, the manipulation automatically resulted in an inflated valuation. What happened next is also quite common: the deal team responsible for the acquisition had limited interaction with the finance department. They conducted their due diligence until the transaction closed and then handed the file over to finance with almost no communication or proper handover.
The newly acquired subsidiary was not considered material at the group level. So it did not immediately attract close attention, either internally or externally. As a result, the finance team did not discover the accounting manipulations until quite late. And as you can imagine, this triggered extensive work to unravel and rebuild the entire case.
The Fraud Triangle: How Weak Controls Create Opportunity.
The fraud triangle highlights three ways fraud creeps in: pressure, opportunity and rationalisation. In M&A buyer beware fraud, the lack of due diligence investigations creates an opportunity, which facilitates the justification for wrongdoing. This gap can be closed with stronger controls and processes that discourage fraudulent behaviour. If there is no opportunity, the rationalisation is removed too.
Two Actions to Prevent Buyer Beware M&A fraud
- Bridge the control gap between M&A teams and finance teams
One of the structural flaws in this case is the lack of pre/post-acquisition communication between the M&A team and the acquirer’s finance teams. The M&A team does not have access to accounting control tools; the finance teams are only involved after the signing, when the manipulations are already integrated into the balance sheets that were submitted. The acquiring company is left exposed by limited financial due diligence, including no follow-up on open issues and no post-acquisition sanity check. - Remove the excuse for fraud by making every manipulation visible
The manager of the acquired company was able to carry out these manipulations because he knew that due diligence would be limited and that post-acquisition controls would be delayed. Organisations can counter this by deploying automated monitoring as soon as the data is retrieved, the platform makes any historical anomalies visible. Even if discovered after closing, these irregularities make it possible to activate contractual guarantees and build a documented case for legal recourse.
How Organisations Manage the M&A Process to Avoid the Buyer Beware Fraud
- Retrospective analysis of accounting manipulations in past financial years
A quick and efficient review of accounting history. Forensic finance platforms Detection tools can drill down into the financial details of a newly acquired company and apply controls to past data. In this case, it would have detected recurring manipulation patterns, expenses wrongly capitalised over several financial years and fictitious turnover recorded at the end of the period, well before their impact was definitively consolidated in the acquiring group’s accounts. - Detection of atypical expense/capitalisation classifications
Applying control and consistency of fixed asset policies. One of the vectors of manipulation in this fraud is the reclassification of expenses as fixed assets to artificially inflate the result. Organisations need to introduce specific controls on the consistency of fixed asset policies: amounts, types, patterns in relation to industry standards and previous financial years. These anomalies, which are invisible in a one-off audit, are immediately apparent in an automated and comprehensive analysis. - Collaborative platform to ensure M&A/finance continuity
Use a platform where all financial functions can work together. So finance teams are involved in the integration process from the day after the deal is signed. M&A teams can document the context of the acquisition, accounting teams can carry out post-closing diagnostics, and internal auditors can access it for their investigations. This continuity of management, which was lacking in this case, is precisely what prevents the late discovery of manipulations. - Monitoring consistency between recorded turnover and cash flow
Fictitious turnover automatically creates inconsistencies between the income statement and actual cash flow. Organisations need a system that cross-checks these two dimensions: high turnover without corresponding cash receipts, or with abnormally long customer payment terms, is an immediate red flag. This type of control would have exposed the artificial inflation of turnover as soon as the data was retrieved.
Organisations need a process that conducts a thorough audit of the accounts. In the weeks following the acquisition, technology can apply automated analyses to all available financial years and then identify anomalies that limited due diligence have failed to detect. Once companies implement this technology, it can prevent fraud and create a climate of security.
