Series 79 – Investment Banking Representative Exam Due Diligence & Deal Structuring 1 — Questions and Answers
Question 1: What is the primary purpose of due diligence in an investment banking transaction?
- To negotiate the final purchase price before signing
- To verify and validate material facts about the target company before closing (Correct answer)
- To prepare marketing materials for potential buyers
- To register securities with the SEC on behalf of the issuer
Correct answer: To verify and validate material facts about the target company before closing
Due diligence is conducted to verify material facts, identify risks, and validate information about the target so that the buyer or underwriter can make an informed decision.
Question 2: Which type of due diligence focuses on examining a company's financial statements, accounting policies, and historical earnings quality?
- Legal due diligence
- Operational due diligence
- Financial due diligence (Correct answer)
- Environmental due diligence
Correct answer: Financial due diligence
Financial due diligence examines the target's historical financial statements, accounting practices, and earnings quality to confirm reported results are accurate and sustainable.
Question 3: A 'quality of earnings' (QoE) analysis performed during due diligence primarily assesses:
- The accuracy of the target's product pricing strategy
- Whether reported earnings reflect sustainable, recurring cash flows (Correct answer)
- The adequacy of the target's employee benefit programs
- The enforceability of the target's customer contracts
Correct answer: Whether reported earnings reflect sustainable, recurring cash flows
A QoE analysis adjusts reported earnings to remove one-time items, non-recurring revenues, and accounting distortions, revealing the true recurring earnings power of the business.
Question 4: In an M&A transaction, a 'virtual data room' (VDR) is primarily used to:
- House executed transaction documents after closing
- Provide a secure, controlled environment for sharing confidential due diligence documents (Correct answer)
- Store the buyer's internal valuation models and bid strategies
- Archive regulatory filings submitted to the SEC
Correct answer: Provide a secure, controlled environment for sharing confidential due diligence documents
A VDR is a secure online repository where sellers share confidential company information with prospective buyers during the due diligence process, controlling access permissions.
Question 5: Which document typically governs the due diligence process and outlines the terms under which confidential information will be shared with a potential acquirer?
- Letter of intent (LOI)
- Definitive purchase agreement
- Non-disclosure agreement (NDA) (Correct answer)
- Fairness opinion letter
Correct answer: Non-disclosure agreement (NDA)
An NDA (also called a confidentiality agreement) must be executed before sharing proprietary information, legally binding the recipient to protect the seller's confidential data.
Question 6: Legal due diligence in an M&A transaction typically includes review of which of the following?
- Customer satisfaction surveys and net promoter scores
- Gross margin trends over the past three years
- Pending litigation, regulatory compliance, and material contracts (Correct answer)
- Capital expenditure budgets and depreciation schedules
Correct answer: Pending litigation, regulatory compliance, and material contracts
Legal due diligence focuses on identifying legal exposures including pending lawsuits, regulatory issues, material contract terms, and intellectual property matters.
Question 7: During due diligence, 'normalized EBITDA' adjustments are made primarily to:
- Inflate the target's reported earnings to justify a higher purchase price
- Remove non-recurring items and owner-specific expenses to show sustainable operating earnings (Correct answer)
- Convert GAAP earnings to a cash-basis accounting measure
- Reconcile differences between the target's domestic and foreign operations
Correct answer: Remove non-recurring items and owner-specific expenses to show sustainable operating earnings
Normalizing EBITDA removes one-time charges, non-recurring income, and above-market owner compensation to present a cleaner view of the business's ongoing earnings capacity.
Series 79 – Investment Banking Representative Exam Due Diligence & Deal Structuring 1
What is the primary purpose of due diligence in an investment banking transaction?