Buy-Side Due Diligence - Warranty Reserve Analysis

SCENARIO
Costs of warranty-related claims not separately tracked

Private equity firm is seeking to acquire a manufacturer and marketer of custom home building products.

In order to conform to industry standards, Target began providing a ten-year limited lifetime warranty on products, including a one-year warranty on installation within the last three years. 

Target claims historical warranty costs are not material, but does not sufficiently track these expenses or maintain any reserve for future warranty-related claims.

APPROACH/ANALYSIS
Perform an analysis to approximate an appropriate warranty reserve amount

Laurus’ approach included:

• Using publicly available information of industry competitors to determine warranty-related claims and expenses as a percentage of sales.
• Applying the percentage factor from above to historical sales of target since adoption of new warranty policy to determine an appropriate reserve as of the proposed transaction close date.
• Creating a waterfall analysis to illustrate changes in the warranty reserve over time to Target management.

OUTCOME
Reduced purchase price through working capital peg

As a result of the analysis prepared by Laurus, client was able to negotiate an effective reduction in purchase price by requiring Target to record a warranty reserve and include this amount in the calculation of the pre-established working capital peg.

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