We have written before about mergers and acquisitions and potential reasons to consider in your growth or exit strategies, and generally, what the process entails. Whether you are a target or acquiring company, due diligence is a critical element of any transaction. In this post, we discuss what you need to know about due diligence in mergers and acquisitions, including what it is, why it matters, and how it helps set your company up for success.
What Does Due Diligence Mean in Mergers and Acquisitions?
Due diligence in mergers and acquisitions is a comprehensive analysis of the target company’s books, records, contracts, financial statements, tax returns, corporate culture, intellectual property, real property, equipment, in order for the acquirer to satisfy itself that the transaction and post-closing integrations will result in the benefits anticipated when negotiating the letter of intent. The official process begins with signing a confidentiality agreement and a letter of intent. Typically, the buyer conducts due diligence with the help of internal personnel and external advisors such as business lawyers, tax attorneys, financial professionals, auditing firms, asset appraisers, cybersecurity analysts, and other industry consultants.
Five Key Reasons Due Diligence Matters in Mergers and Acquisitions
Companies should conduct due diligence in mergers and acquisitions with the following goals in mind:
1. Understanding the Target Company
If you’re considering merging or acquiring a company, you already know something about it. However, due diligence lets you peek behind the curtain for a more in-depth look. You can analyze everything from management structure and strategic goals to revenue models and customer contracts.
2. Mitigating Risks and Identifying Opportunities
As you look more closely at an organization, you will learn more about its selling points and drawbacks. On the upside, you may discover additional synergies, favorable business prospects, and valuable cost-cutting opportunities. On the downside, you may uncover environmental problems, labor law violations, or pending litigation.
3. Complying With Laws and Regulations
Due diligence can alert you to financial, regulatory, and legal compliance issues prior to a merger or acquisition. You may spot red flags, such as government investigations (including tax or other regulatory audits) or intellectual property issues. Verifying compliance beforehand helps save time, resources, and reputational damage later.
4. Determining Valuation Adjustments
Evaluating financial statements, cash flow, revenue streams, and historical metrics helps you identify hidden issues that may affect the valuation. Specific issues revealed during due diligence and be addressed by negotiating one or more of purchase price adjustments, escrows, additional warranties, and specific indemnity provisions.
5. Integration Planning
The information gathered during due diligence can be used to develop a successful integration plan. This includes identifying potential synergies, streamlining operations, and managing cultural differences.
Reverse Due Diligence: A Seller’s Perspective
While traditionally associated with buyers, sellers can also benefit from performing due diligence on themselves, known as “reverse due diligence.” This proactive approach helps sellers:
1. Identify Weaknesses
By understanding their company’s shortcomings, sellers can address them before potential buyers uncover them. This can help to avoid surprises and negative negotiations.
2. Enhance the Sales Process
A well-prepared seller can streamline the due diligence process for buyers, leading to faster and smoother transactions.
3. Maximize Valuation
By highlighting their company’s strengths and addressing potential weaknesses, sellers can position themselves to achieve the best possible valuation.
Types of Due Diligence in Mergers and Acquisitions
Proper due diligence reviews each of the following areas:
- Financial — A financial analysis involves looking at financial statements, accounting practices, fiscal performance, assets, and liabilities.
- Taxes — Tax due diligence helps clarify the target company’s tax obligations and compliance, plus the potential tax liabilities of the buyer.
- Legal — Legal due diligence reviews legal documents (including contracts, licenses, and intellectual property rights) and any legal issues like antitrust investigations or pending civil lawsuits.
- Operational — An operational assessment looks at internal processes, from supply chain management and production facilities to IT systems and quality control measures.
- Commercial — Commercial due diligence assesses market share, competitive position, marketing strategies, customer satisfaction, and growth potential.
- Technological — These evaluations analyze technology infrastructure and practices, including software and hardware, cybersecurity measures, and data privacy compliance.
- Personnel — From employment policies to compensation programs, human resources due diligence is essential for risk management and integration planning.
- Regulatory — This type of due diligence looks at the target company’s industry compliance and the requirements for regulatory approval.
- Environmental — Environmental due diligence focuses on ecological variables like hazardous waste, contamination risks, and sustainability practices.
- Reputational — Due diligence should also seek out business intelligence about the reputation and integrity of potential partners.
Need Help With Due Diligence in Mergers and Acquisitions? Contact Us Today
If you are acquiring, selling, or merging with another company, Wilson Ratledge, PLLC, can facilitate the process. We offer professional legal and financial advice on mergers and acquisitions for small businesses and multi-million-dollar companies across various industries. Call 919-787-7711 or contact us online to see what our team can do for you.