We’ve all heard the phrase due diligence. We might say we’re doing it when selecting our next holiday spot or looking into a possible match on a dating site. However, due diligence most accurately refers to conducting a comprehensive review before entering into a business transaction. This article will outline the importance of due diligence in mergers and acquisitions.
What is due diligence in mergers and acquisitions?
During due diligence, you’ll thoroughly investigate a target company. By gathering information and analyzing the documents and data, you can identify potential risks, opportunities, or other factors that could impact the transaction.
Due diligence for a merger or acquisition typically involves:
- Reviewing financial records
- Analyzing market trends
- Conducting background checks
- Assessing legal and regulatory compliance
- Evaluating operational and management structures
Due diligence aims to provide an objective and informed assessment to guide informed decisions and minimize potential risks.
Learn also the difference between a merger and an acquisition.
Why due diligence matters in mergers and acquisitions
Due diligence is a critical component of mergers and acquisitions (M&A). The comprehensive review of a target company’s financial, legal, operational, and strategic aspects helps buyers or investors decide to acquire or invest.
An in-depth understanding of the target’s assets, liabilities, risks, and potential synergies can support determining a fair purchase price, negotiating deal terms, and assessing the potential return on investment.
A buyer or investor risks fraud or misrepresentation without the necessary due diligence steps. This process can uncover discrepancies or inconsistencies in the target’s financial statements or other records that could lead to significant risks for the buyer or investor.
For the seller, the due diligence stage helps establish credibility. The review may also indicate the seller’s company is worth more than initially thought.
Importance of due diligence in Mergers and Acquisitions
Due diligence can uncover hidden risks in merger and acquisition transactions. Risks might include regulatory compliance issues, hidden liabilities, or declining market conditions. The target company’s value could be misunderstood if these go undiscovered during due diligence. This could significantly undermine the transaction’s success.
Due diligence can also help identify opportunities that maximize the value of the transaction. These might include discovering:
- Potential synergies between the target company and the buyer or investor, including cost savings, revenue growth opportunities, or increased market share.
- Undervalued assets, such as intellectual property, patents, or proprietary technology, that when leveraged properly can create value.
- New markets or products that the buyer or investor could enter or develop with the target company’s resources or expertise.
- Strong management or operational practices the buyer could implement to improve their operations.
- Cost-cutting measures or operational efficiencies that could improve financial performance (and transaction value).
Navigating Merger and Acquisitions: What to Expect and How to Prepare
The due diligence stage is an intensive, multi-step process. You can expect the following activities as part of the review of a target’s finances, operations, strategy, and other aspects.
Buyer side
First, the buyer or investor gathers information by requesting target company financial statements, tax returns, employee records, intellectual property filings, contracts, inventory schedules, and other organizational documents.
Next, all this information is reviewed and analyzed. The buyer or investor is looking to uncover risks, liabilities, or opportunities. They will also review applicable laws and regulations to verify the target company complies with environmental protections, employment law, and data privacy.
Some buyers or investors will also conduct site visits to interview key executives and employees and view facilities. This is a chance for them to gain a first-hand understanding of the company culture and how it operates. It is also useful in terms of uncovering fraud or misrepresentation.
After reviewing all the information collected to ensure proper business practices, the buyer will conduct a thorough financial analysis. This evaluation of the company’s financial health and value determines the fair market value of the target company and negotiates a purchase price.
Seller side
Buyers and investors ask for a wide range of information. In some cases, their strategy is to wear you down by requesting endless documents, discovering problems, and attempting to renegotiate your deal. Others may simply be detail-oriented or risk-averse. Preparing to focus time and effort on this stage can help you reach a smooth closing sooner. Cooperating and being communicative throughout can streamline the process. It’s also a good idea to establish a contact person responsible for your side of the process and managing requests.
This article has explored the important role of due diligence in mergers and in acquisitions and what to expect during the process. Review the article, “What does an M&A attorney do?”, to help guide your decision. It may also be helpful to consult with a legal expert.