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1. What is Due Diligence?
Due diligence refers to the process of investigation or audit of a deal or investment opportunity which helps a buyer with an assurance of what they are buying. It basically refers to the process of investigating any business or person before signing a contract.
2. Why is Due Diligence Important to The M & A Process?
Due diligence is a very imperative aspect of M&A transactions as it helps the buyers in getting a sniff of the actual business aspects they are interested in purchasing. It is the due diligence process that helps the buyer in understanding the different synergies, growth potential of a business and helps them in getting their hand on more customers. An adequate due diligence also helps a buyer to maximize their revenue generation opportunities and minimize their loss areas.[1]
Due diligence not only bears fruit for the buyer but also reaps fruit for the sellers. Due diligence helps the sellers in detecting potential value detractors which helps them in gaining buyer’s confidence.[2]
3. Benefits of Due Diligence in M & A Process
Due diligence helps the buyer in getting detailed information about the target firm and helps them in adjusting themselves according to the expectations of the target firm. An adequate due diligence also helps the acquirer in protecting themselves from the potential risks that may arise during the transactions. Due diligence also helps in putting practical steps and efficient planning for the smooth functioning of the integration process. Further due diligence also helps in building a good rapport between buyer and the target company[3].
4. M & A Due Diligence Checklist
Corporate documentation –Before merging with any other firm, it is imperative that the legal structure of the target company has to be examined and understood. The buyer should work towards inspecting the corporate records, certificate of incorporation (with the all amendments), bylaws, minute books with due assiduousness for ensuring a smooth and a hassle-free transition.
Financial documentation and data – Financial due diligence plays a very imperative role towards determining the financial benefit that a company may reap from the acquisition. This process helps the buyer firm determine the value of the firm and the financial risks associated with the purchase. Financial diligence also helps in identifying the current financial situation and the profitability of the target company.
Information on customers – Customers are considered as the heart and soul of every business. Before buying or merging with any business, the buyer has to look upon the possible effects a merger is going to have upon their old and new customer base.
Historic or current legal issues –. The buyer’s legal team should also try to get their hands on the information related to the legal cases that are pending against the seller. Thus, the buyer’s legal team should make necessary efforts for inquiring about the legal liability, the claim value and necessary legal documents required for ascertaining the same.
Employees and departments – A due diligence process also involves determining the employment agreements of employers and employees for ensuring that none of the agreements should be triggered or effected with the change in control. Due diligence also helps in calculating the amount of consideration that a buyer would have to shell out for future considerations.[4]
Property –During due diligence it is imperative that the seller should provide a complete list of all the tangible and intangible assets to the buyer. The buyer should make a thorough analysis of the bills, mortgages, loans and all the relevant contracts associated with the assets of the business.
Culture Due diligence– Corporate culture is considered as the key element for profitability and success for any firm. Every company that merges with another company tries to ensure that there is a proper balance of corporate culture in the organization. Conflicts of cultures during mergers pose a serious threat to the growth and development of an enterprise, so an efficient due diligence has to be conducted on corporate culture for ensuring a hassle free working environment.
Legal due diligence -The objective of legal due diligence is to closely analyze the seller’s legal documents and to evaluate the legal position of the target company. During legal due diligence the buyer’s advocate has to look into the liabilities and obligations of the target firm which may have an impact on the value of the firm. Legal due diligence also helps the buyer in determining the risks and ownership associated with the assets of the target firm.
5. Due Diligence Process
The Data Room
Due diligence is a very confidential process and thus is conducted inside a data room with minimal access. The people who are involved in the due diligence process are only provided with the access of the data room. All the requisite documents are brought in the data room for close scrutiny, and after undergoing detailed examination the documents are returned back. As the process of due diligence progresses more and more documents are brought under the scanner and this whole process is carried on with great caution, in order to avoid any last minute red flags. But, the concept of data rooms are becoming the things of the past, now a days the concept of digital data room has been the vogue. Instead of bringing lawyers, bankers, investors at one place, the target company uploads everything into the digital version of the data room. The digital version of the data room prevents any unauthorized access to the confidential data and ensures that only the required persons get access.
Setting up of data rooms sets the base for a complex process which starts with dividing up of responsibilities, in order to avoid any duplication of efforts. Conducting due diligence in M&A transactions is a very herculean task and can become quite cumbersome if not committed with profound efficiency and dedication. In order to ensure the same, a detailed checklist is provided to the seller. The list provided to the seller should be updated from time to time and this updated list can be used for triggering the seller for delivering any documents.[5]
6. Diligence Report
After all the documents are examined, a report relating to it is prepared. This report sometimes runs into hundreds of pages, so in order to avoid the extra sweat most firms prefer it in precise form with most data attached as annexures. An executive summary usually stating the highlights is also prepared for providing a bird’s eye view of the whole report[6]. Usually, a due diligence report is delivered in black and white, but delivering it involves some expense. So, proper communication has to be made regarding the manner in which the report is to be made. An oral report or a short-written report displaying the red flags is also the solution. The report so made should provide for recommendations for improvement or for solving any particular hurdle being faced by the firm.
7. Cases of Inadeqaute Due Diligence
An inadequate due diligence can leave an indelible impact on the organization which can haunt the functioning and reputation of a company for a considerable amount of time. There are many cases in which an inadequate due diligence has affected the company.
i. Google And Nest
Google acquired nest labs in 2014 to enter into the market of smart homes. While google worked efficiently on the software but could not cope up with the hardware and product innovation. This led to internal fighting and politics within the Nest which affected the product innovation of the company and ultimately both the founders had to later quit the company.
ii. HP and Autonomy
In 2011, HP acquired Autonomy, a European data analytics company. But, later it was found out that Autonomy had cooked their books which resulted in the increase of their prices during acquisition. The company(HP) could not actually gain anything from the acquisition and ultimately had to write down the acquisition as a $9 Billion Loss.
iii. Ebay and Skype
In order to diversify their business ebay acquired Skype in 2005. But their expectations were far away from reality as not many of their users found any reason to communicate via skype. This resulted in the change in the management of the skype four times in four years and ultimately the losses piling from the same forced the company to sell 65% of skype shares to Sea Lake.
[1] Adam putz, M&A 101: The role of due diligence in M& A Transactions (January 5, 2019, 10:00A.M.) https://pitchbook.com/news/articles/ma-101-the-role-of-due-diligence-in-mergers-and-acquisitions.
[2]Dana Erith, The importance of due diligence in M&A Transactions, EideBailly (January 5, 2019, 10:30 A.M.) https://www.eidebailly.com/insights/articles/the-importance-of-due-diligence-in-ma.
[3] Amelia Henderson, A guide to M&A due diligence, DueDil (January 5, 2019, 12:15 P.M.) https://www.duedil.com/blog/a-guide-to-m-a-due-diligence.
[4] David M loev, Due Diligence in M&A transactions, Academy of Attorney CPAs (January 5, 2019, 12:30 P.M.)
[5] Thomas Vaughn, Conducting proper due diligence to ensure a successful acquisition, Smart Business (January 6 2019, 01:00 P.M.) http://www.sbnonline.com/article/conducting-the-proper-due-diligence-to-ensure-a-successful-acquisition/.
[6] Anubhav Pandey, How can I learn to perform due diligence? iPleaders (January 6 2019, 2:00P.M.) https://blog.ipleaders.in/how-to-perform-a-due-diligence/.
Author Bio
Thank you, Eshaan, for this content! While road mapping, it may seem difficult to forecast how much due diligence is enough. In my experience, the diligence process should only last between 30 and 60 days. This is achievable IF delegated to an efficient, dynamic team from multiple business functions. If not, it can last way longer and take away precious time. For fellow readers, I also found some useful info on dealroom.net . I think a few posts there complement this article nicely