Financial due diligence in the education sector

Many schools are finding the current pressures in the economy very challenging. The cost of living crisis is squeezing households, and with the potential changes regarding VAT on school fees this may increase. As a result, independent education may be or become something households can no longer afford. We are seeing a significant increase in schools exploring mergers and acquisitions and therefore needing financial due diligence (FDD) services to support their plans.

FDD is the investigation of a company's financial records and other relevant financial information prior to a merger, acquisition or other significant business transaction. The objective of FDD is to evaluate the financial health and stability of the target school (the “Target”), identify potential financial risks, assess the accuracy and reliability of the financial information provided by the Target, and identify any potential issues which could impact the completion of the deal.

This review of the financial statements, tax records, accounting practices, financial projections, and other financial data determines the attractiveness of the Target. This helps the lead school in the case of a merger or the buyer in the case of an acquisition, to make an informed decision on value and where appropriate negotiate a fair price for the transaction.

In recent years, the education sector has seen a rise in corporate and private equity buyers acquiring pre-schools, academies and independent schools and consolidating the market. Education groups are seeking to generate synergies from bringing schools together under one umbrella, in terms of cost efficiencies and sharing best practices and educational standards.

Testament to this buoyant market for M&A activity, here at Crowe we have been highly active, advising clients on a considerable number of acquisitions of independent schools and nurseries, in particular.

So why should an acquiring school engage an independent firm, to undertake FDD on a Target? FDD has an essential role to play in the education sector, key benefits include the following:

1. Financial performance - Identifying strengths, weaknesses, risks and opportunities

FDD helps understand and explain the financial performance of the school by evaluating the key drivers of performance such as pupil numbers, average fees, teacher/pupil ratios, billing cycles, grant income and extra-curricular income.

FDD is not simply a review of the accounts but is much more commercial and seeks to understand the underlying drivers of the revenues and costs at a granular level.

It can also help assess the cash flow generation of the school and its working capital needs so that the lead school or acquirer understands any additional cash requirements post-merger or completion of the deal. Subjecting the cash flows to stress testing and sensitivity analysis helps identify where the potential cash flow weaknesses or risks lie.

FDD will also consider issues related to financial reporting, budgets, potential liabilities or weak internal controls. By identifying these risks, steps can be taken to address them, such as implementing stronger financial controls or creating a more transparent budgeting process, to preserve value and mitigate risks identified.

FDD services are also needed for schools where they are the Target. This will assure the Governors over the financial sustainability of the acquiring company or if they are entering into a business combination, the entity they are merging with.

2. Negotiations

Where a school is subject to acquisition by a corporate group, there will be a consideration for the assets of the school. FDD provides the acquirer with an in-depth analysis of historical financial performance to assist with negotiations and assessing the value of the Target. FDD will assess the underlying profitability of the Target which drives the valuation and identify non-recurring income and costs that may have distorted the results for a particular year. This ensures that the buyer is having informed negotiations with the Target and is aware of any potential challenges or risks associated with the transaction.

3. Avoiding surprises

FDD can also help avoid surprises that may arise after a transaction is completed. By conducting a thorough analysis of the financial data, FDD can help identify any potential issues that may arise after the transaction is completed, such as tax liabilities or hidden financial liabilities. This enables more informed decisions and negotiations before the arrangements are finalised.

4. Fundraising and investment

FDD can also be valuable when seeking funding or investment for a particular project, and investors or funders may require FDD as a condition of providing the funds.

Where a charitable school is mortgaging charity land or property to secure a loan or grant, S.124 Charities Act 2011 requires governors, to obtain and consider proper advice given to them in writing, before executing the mortgage.

In the case of a mortgage to secure the repayment of a proposed loan the relevant matters are:

(a)whether the loan or grant is necessary in order for the governors to be able to pursue the particular course of action in connection with which they are seeking the loan or grant,

(b)whether the terms of the loan or grant are reasonable having regard to the status of the charity as the prospective recipient of the loan or grant, and

(c)the ability of the school to repay on those terms the sum proposed to be paid by way of loan or grant.

Whilst this advice can be provided by a qualified person often the skills of the FDD advisors can be helpful in more complex cases.

5. Post-deal activities and monitoring the business

The FDD report will contain a list of items capturing the identified risks, weaknesses or opportunities along with recommendations about how to address or capitalise upon these, post-merger or transaction. This will ensure that the group under new ownership gets off to a positive start, with clear intentions.

FDD advisors often have considerable experience across a broad range of sectors and can therefore bring expertise in terms of financial reporting, setting KPIs and building reporting dashboards to help monitor the business post-completion.

They can also assist management in the preparation and building of complex financial forecast models, to support management in making informed business decisions and setting plans based on robust and accurate data.

How can Crowe help?

FDD is critical in the education sector to identify financial risks, ensure a thorough understanding of the financial performance and position of the Target, facilitate mergers and acquisitions, and support fundraising and investments.

It also feeds into the post-deal period and can assist with the monitoring of the business going forward. By conducting thorough FDD, educational institutions can make informed decisions and more effectively manage the financial risks associated with a transaction.

For further advice, please get in touch with Dan Nixon or your usual Crowe contact.