Due diligence is indispensable before every M&A transaction, where parties inspect the target company, by way of investigation, auditing and reviewing all the details provided in the documents. Due diligence is the systematic method to analyse legal, financial, corporate governance & environmental issues and to ascertain the contingent liabilities of the target enterprise with the ultimate objective of mitigating the future risk. The acquirer incurs enormous costs in the hiring of legal, financial, Information technology and Human Resources professionals in the due diligence process.
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Importance of DUE DILIGENCE to buyer and seller
Due diligence allows the buyer to feel more comfortable regarding the transaction and enables them to exercise informed decisions. Further, the Due diligence process reveals the real valuation of the company, which assists the buyer to negotiate the price.
In many cases the seller side conducts internal Due diligence, as going through rigorous financial and non-financial examination reveals the fair market value of the company and helps the seller to negotiate the price with the buyer.
Importance of Due diligence and its functions in M&A transactions
1. The Due diligence is conducted to determine the amount of contingent liability and risk, the target company has been associated with.
2. In the case of a manufacturing unit, physical evaluation of the machines and equipment are mandatory to estimate the actual book value and working condition of the plant and equipment.
3. Due diligence in the M&A transaction identifies the issues related to corporate governance, Legal, environmental compliances.
4. Due diligence works as a prerequisite before drafting the definitive agreement, as it verifies the crucial details of the M&A transactions.
5. Due diligence works as a caveat to the investor and identifies shortcomings in the target company.
6. Identifies the revenue recognition method used by the company.
7. Identify whether the M&A transaction would lead to cultural differences if any.
8. Proper Due diligence can showcase unforeseen problems which could be rectified by the parties before entering into a definitive agreement.[1]
9. The due diligence process helps evaluate the fair price of the target company, which helps in purchase price determination along with payment method.[2]
Type of DUE DILIGENCE
1. Hard DUE DILIGENCE
Hard Due diligence involves the evaluation of the financial data of the target company. This type of Due diligence sees the quantitative aspect as it involves financial analysis, which gives a picture of suggested financial growth.
2. Soft Due diligence
Soft Due diligence focuses on the qualitative part, which includes the employees and key managerial professionals of the company. For example, it is important to study the cultural differences before the acquisition of a government entity by a private company.
Activities involved in Due diligence
1. Prepare Due diligence checklist
2. To overview the target company
3. Examine, whether the target company will strategically fit with the buyer
4. Analysis of the competitive environment of the target company
5. Analysing the financial overview and future projection
6. Conduct intellectual property Due diligence
7. Legal Due diligence
8. Environmental Due diligence
9. Understand the company’s target base
10. Review insurance policies of target company’s business
11. Review extent of related party transaction
12. Review general corporate matter
13. Review properties of the target company
Online Data Room (ODR)
The Due diligence in M&A transactions is completed via an online data room. Online Data Room is a secured online repository, where important documents are stored. It simplifies access to the shared document to both the Due diligence team and for security reasons, copying and downloading are prohibited.
The following are the common attributes and characteristics of an effective data room:-
- The target company provide to the buyer as early, at the latest immediately following the parties finalizing the letter of intent or term sheet.
- The data room has a logical table of contents or directory and full-text search capabilities (which requires scanning of all documents with optical character recognition software).
- The data room permits bookmarking within the application.
- Subject to confidentiality concerns, the buyer is permitted to print documents for offline review.
- The data room is indispensable to any due diligence checklist provided by the buyer to facilitate cross-referencing and review.
- Updates to the data room are marked or trigger email notifications to the buyer’s counsel, to help ensure that nothing is missed as supplemental materials are added during the process.
Conclusion
Therefore, the Due Diligence process is essential before every M&A transaction, if it indicates several faults in the target company then the investor has the option to either resolve the issue before entering into the transaction, break the deal, or price is further negotiated and reduced.
[1] Andy Marker, ‘Everything You Need to Know About Due Diligence: Types, Roles, and Processes’ < https://www.smartsheet.com/due-diligence-guide > accessed 8 November 2021
[2] Trishla Dwivedi, ‘Role of Due Diligence in Mergers and Acquisition of corporations’ (26 February 2021) < https://timesofindia.indiatimes.com/readersblog/hail-to-feminism/role-of-due-diligence-in-mergers-and-acquisition-of-corporations-30024/> accessed 8 November 2021
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