Undertaking a merger or acquisition process is no small endeavor, and in fact, it may be one of the most complex tasks in the business world. Things can get complicated fast when you dive into the numbers and unravel the process of actually completing a deal. This is why taking the time to do high-quality due diligence–or working with a team that understands the due diligence process–is paramount.
In this exploration, we’ll unravel why this meticulous process is indispensable for corporate transactions.
What is Due Diligence?
Due diligence (DD) is the meticulous investigation and analysis conducted by parties involved in a transaction.
It serves as a comprehensive background check, revealing the intricacies and potential pitfalls that might lurk beneath the surface.
- Importance of thorough due diligence for both buyers and sellers: For buyers, DD ensures they aren’t stepping into a financial minefield, providing a clear picture of the risks and opportunities associated with the target company. Sellers, on the other hand, benefit by substantiating the value they bring to the table, instilling confidence in potential acquirers.
- DD also plays an integral role in the pre-closing phase: Consider due diligence the gatekeeper of the pre-closing phase. It’s the last line of defense before sealing the deal, ensuring that all parties have a comprehensive understanding of what lies ahead.
Key Objectives of the Due Diligence Process
Let’s delve into the key objectives that make due diligence indispensable in the M&A landscape.
- Ensuring transparency and risk mitigation: Due diligence acts as a transparency advocate, spotlighting potential risks. By identifying and mitigating these risks early on, it empowers both buyers and sellers to navigate the M&A landscape with clarity.
- Assessing true value and potential risks: Beyond a checklist, due diligence is a deep dive into understanding the authentic value of the target company. It unravels financial intricacies, operational nuances, and market positioning, providing a comprehensive evaluation beyond surface-level assessments.
- Making Informed Investment Decisions: Informed decisions are paramount. Due diligence equips decision-makers with vital insights, aligning acquisitions with strategic goals and minimizing unforeseen setbacks.
Timing and Placement in the M&A Process
As they say, timing is everything. In any M&A scenario, there’s no doubt that both parties want to get things underway, verified, and completed as soon as possible so that all parties involved can reach the end goal they had in mind.
- When does due diligence usually occur? The DD process typically kicks off after the signing of a Non-binding Offer/Letter of Intent (LOI) and before the finalization of the deal (negotiations and signing of Binding Offers).
- How long does the process usually take? This depends heavily on the scenario and can vary in duration depending on the size and complexity of the transaction (in European mid-market most often 2 months).
Parties Involved
Just like any well-choreographed performance, there are key players gracefully gliding across the stage. In this section, we’ll lift the curtain to unveil who takes part in this meticulous dance of corporate scrutiny.
- On the seller’s side: Owners/management team, M&A advisors, legal advisors (and optionally financial, tax, and IT due diligence advisors if the deal is bigger and there is, for instance, vendor due diligence prepared upfront),
- On the buyer’s side: (1-3 investors invited to this stage based on the quality of NBOs): Owners/management team, internal experts, and due diligence advisors (financial, legal, tax, operational, IT).
Elements of the Due Diligence Process
Let’s talk shop. In this section, we’re delving into the nuts and bolts, the ABCs, or shall we say, the XYZs of the due diligence process. It’s the part where we pull back the curtain and look at the specific components that make this whole corporate inspection thing tick.
Common elements usually include:
- Document Analysis by the Buyers (main goal)
- Expert Calls (Communication with key personnel for clarifications)
- Management Meetings (In-depth discussions with the target company’s management and Clarification on strategies, future plans, and potential challenges)
- Q&A session (buyers have 100-150 to ask on a Virtual Data Room platform and make the received information legally biding in SPA, as the report from Q&A is attached to transactional documents)
Areas Investigated and Common Documents
So, what exactly are stakeholders taking a look at during the due diligence process? The answer is, in short, a lot of things. The buyer must ensure the quality of their merger or acquisition partner is up to its acclaimed value prior to finalizing the deal, and as a result, nothing is off limits.
Financial Due Diligence
- Financial statements (balance sheet, income statement, cash flow statement)
- Audited financial reports
- Revenue and cost analysis
- Reconciliation between management reports, financial statements, and trial balances
- Working Capital
- Net Debt
- Budgets and forecasts
- Debt and liabilities
Tax Due Diligence
- Tax returns for the past several years
- Details of any tax disputes or audits
- Information on tax compliance
- Documentation of tax credits and incentives
- Transfer pricing documentation
Legal Due Diligence
- Corporate documents (articles of incorporation, bylaws)
- Contracts and agreements (top 10 customers and suppliers)
- Litigation history
- Intellectual property documents
- Regulatory compliance
- Employment contracts
- Pending legal disputes or potential liabilities
HR Due Diligence
- Employee contracts and handbooks
- Organizational structure
- Employee benefits and compensation details
- Employment litigation history
- Workforce demographics
- Compliance with labor laws
IT Due Diligence
- Information on existing IT infrastructure
- Cybersecurity policies and practices
- Software and hardware inventory
- Data protection and privacy compliance
- IT contracts and licenses
- Any history of data breaches or security incidents
Environmental Due Diligence
- Environmental permits and compliance records
- Reports on environmental impact assessments
- History of environmental incidents or violations
- Contingent liabilities related to environmental issues
- Compliance with environmental laws and regulations
Challenges in Due Diligence
Unfortunately, due diligence is designed to uncover problems. Although you hope to find very few, the revelation of something is inevitable.
Just like any adventure, this one comes with its set of challenges, hurdles, and unexpected twists. In this section, we’ll navigate through the complexities that can throw a curveball into the seemingly smooth process of scrutinizing a business. So, tighten your shoelaces; we’re about to explore the rocky terrain of due diligence challenges.
Time Constraints
- Balancing the need for thorough due diligence with deal timelines
- Conducting efficient due diligence while sticking to a tight schedule
Information Overload
- Dealing with large volumes of data and information
- Implementing tools and technologies to streamline the process
Products of the Due Diligence Process
After the meticulous dissection and unraveling of the due diligence process, it’s time to turn our attention to the tangible outcomes. Let’s look at a few of the products of the due diligence journey—the gems and insights that emerge from the scrutiny.
Due Diligence Report
- Compilation of findings and assessments
- Risk analysis and potential impact on the deal
Recommendations
- Suggestions for deal structuring or negotiations
- Identification of areas that may require further investigation
Final Thoughts: Due Diligence Explained
Conducting thorough due diligence is very much like conducting an extensive home review before buying a home. In the beginning, it might seem a bit unnecessary to do so much homework before conducting the transaction. But, if you discover that the foundation of the home is starting to crumble then you’ll be very happy that you did your DD.
We hope that you’ve found this article valuable when it comes to learning about the due diligence portion of M&A transactions. If you’re interested in reading more, please subscribe below to get alerted of new articles as we write them.
Additionally — we’re always here to help. If you find yourself in need of expert advice from industry professionals for your own M&A hurdles, don’t hesitate to contact us.
