The Buyer side due diligence is sometimes closely related to a fault hunting exercise that often leads to derailing a transaction, instead of a simple key facts checking exercise. In practice this most of the time serves as a constructive purpose in a mergers and acquisition transaction. When the diligence starts most of the time the buyers have already made up their mind about moving ahead with the transaction. So the main aim is not to eliminate the risk, but to identify and then manage the risk to make the transaction fair and dealt in confidence.
One of the main objectives of the due diligence is to clarify and verify if the assumed data used to value the target is apt and rational. Valuation models tend to show the business in a very optimistic light. Due diligence verifies if the assumption will be fine when reviewed for legal compliance, asset ownership and other contracts and regulatory compliance. By this the due diligence serves as a check on the transaction by ensuring the buyer bases the decision on right and raw facts, rather than the optimistic projections.
Due diligence is also very helpful because it identifies risk very early. The due diligence itself won’t eliminate the risk, rather will help in identifying risks early, so that it can be handled effectively. The real value of all the due diligence reports lie in the practical findings and how these findings are applied.
When the risks are clearly identified, they can be divided into 3 main categories. Firstly, key issues that are very important to the deal and are generally set out as condition precedent, that means that these issues need to be settled before the parties complete the transactions. Secondly, minor regulatory and compliance gap which can be managed by representation, warranties and indemnities. Lastly, where a risk that can be defined in clear numbers, such as buyer demand to change the purchase price, though this is not common in due diligence.
The due diligence is shaped by how the transaction is set up. In asset purchase deals, the task is limited to the specific asset that the buyer wants through the transaction. On the other hand, a share purchase deal needs a review of the whole company, because of the past liabilities that needs to be assessed. The main approach in these transaction is to maintain balance, focus on main issues and coordinate effectively for legal, finance and tax teams.
One of the most common misunderstanding is that taking a minority shareholding in a entity needs limited due diligence. Even a minor ownership share can leave the investor with regulatory, reputational and financial risk. Atleast routine checks like search for past and pending litigation should be done. The issue of limited time frame makes it very hard to plan and carry out the diligence effectively. Additional resources can surely make the work go faster but there is a limit to it, trying to shorten it beyond a point starts to reduce the quality of the result.
Also, there is no standard template for conducting due diligence, each target organization operates under its own format due to its industry and regulatory requirements. What all needs to be included in the due diligence depends on the different kind of risks associated with the businesses industry and how the business model operates.
In conclusion, due diligence is a very effective strategic tool, not a defensive task. Its true value comes less from identifying the issues and more from how clearly these issues are identified and dealt within the structure of the transaction. When done effectively, due diligence supports a well-structured decision making tactic and helps set the transaction for success
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