The Purpose and Process of M&A Due Diligence

M&A transactions allow your company to grow, tap into new markets, and gain a competitive edge in the industry. However, with great opportunities come great risks.

Data shows that 70% to 90% of all M&A deals fail. While poor integration bears the blame for most failed M&A projects, ignoring the process of due diligence — or performing the process incorrectly — can also be a significant factor. Due diligence helps identify potential pitfalls, opportunities, and overall feasibility.

So, what exactly is due diligence, and why is it so important in M&A transactions? In this guide, we answer these questions so that you understand how to perform due diligence during your next M&A project.

What Is M&A Due Diligence?

Due diligence is an essential process of thoroughly evaluating a business before entering into a contractual agreement to ensure that it meets your standards and expectations. The goal is to assess the potential risks associated with the M&A deal. If you’re the acquirer, the due diligence process gives you a detailed insight into the target company’s financial, legal, and operational status before proceeding with the transaction.

You can review a wide range of materials during the due diligence process. These include financial documents like balance sheets and cash flow statements.

You can also request employment contracts, company policies, and legal documents to examine compliance. The best thing is to make an M&A due diligence checklist to ensure you don’t overlook any critical details.

Types of Due Diligence

Different aspects of the due diligence process depend on the nature of the deal. Each type of due diligence is important for various reasons and provides valuable information for the acquiring company to make informed decisions about the transaction. The most common types of due diligence that you shouldn’t overlook include the following:

Financial Due Diligence

Financial due diligence focuses on understanding the target company’s financial resources and performance. During this time, the acquiring company will review the target company’s financial statements, including its balance sheet, income statement, cash flow statement, and other financial records. The aim is to assess the company’s revenue, profitability, liquidity, solvency, and cash flow. You should complete a detailed review and analysis of the target company’s financial statements, tax returns, accounting systems, and other financial documents.

Legal Due Diligence

Legal due diligence aims to verify the legal and regulatory compliance of the target company. It includes a review of legal contracts, licenses, permits, litigation history, and any potential liability issues. The legal due diligence process will help you identify any legal risks, such as unresolved legal disputes, pending lawsuits, or regulatory compliance problems.

Operational Due Diligence

Operational due diligence includes a review of production processes, supply chain management, infrastructure, employees, and workflows. This is where you assess potential efficiencies or cost savings that could be unlocked through the merger or acquisition.

Business Due Diligence

Business due diligence is a broad assessment of the target company’s overall value and performance. It includes an analysis of the market (including growth and trends), customers, competitors, products and services, and suppliers. The goal is to assess how well the target business fits into your portfolio or whether it could help you achieve any strategic goals.

IT Due Diligence

IT due diligence typically includes reviewing the target company’s hardware, software, network, cybersecurity, and other IT-related systems and processes. It may also include an assessment of the target company’s IT personnel, policies, and procedures. The scope and depth of IT due diligence will depend on the size and complexity of the target company, as well as the nature of the proposed transaction.

In an era when cyberattacks have become more frequent and sophisticated, cybersecurity due diligence must be a strong focus of the IT Diligence process. This process involves reviewing the target company’s IT systems, applications, networks, policies, and procedures to assess potential security threats. In addition, you should ensure that the target company has adequate protection for its sensitive data and complies with all applicable regulations.

The Importance of Due Diligence

It is important to note that performing due diligence does not guarantee success. However, the process will benefit you in the following ways:

Identifying Potential Risks

M&A deals involve significant risks, including legal, financial, operational, cyber, and more. When you perform due diligence, you will identify these risks and avoid unpleasant surprises after closing the deal. Identifying the risks is vital to understanding the potential deal breakers or changers.

Ensuring the Accuracy of Information

The due diligence process is your opportunity to verify the accuracy and completeness of the information the target company provides. During the process, you can scrutinize the financial statements, contracts, licenses, patents, and other relevant documents to avoid being misled or deceived by the target company.

Evaluating Business Synergies

M&A deals are often motivated by the desire to achieve business synergies, such as cost savings, revenue growth, market share, and strategic positioning. As such, due diligence helps you evaluate the potential synergies with the target company and identify the best ways to integrate the two companies.

Evaluating the Cultural Fit

An M&A deal brings together different corporate cultures, so assessing whether the two companies can work together is vital. The due diligence process will allow you to evaluate how the target company’s culture would fit with yours and minimize integration challenges. This will help you avoid any potential clashes that could derail the deal’s success.

Key Components of Due Diligence

Understanding the critical components of the due diligence process will ensure it is more comprehensive. The major components to consider include:

• The target company’s ownership and structure
• Financials, including balance sheets, income statements, cash flow, and debt
• Contracts with customers, suppliers, and employees
• Intellectual property, such as trademarks, patents, and copyrights
• Legal compliance with applicable laws and regulations
• Information technology systems, including hardware and software
• Environmental issues, such as pollution or hazardous waste
• Strategic fit with the target firm
• The target’s company clients base
• Marketing strategies
• Production capabilities
• Workforce management, including issues like labor disputes
• Reports and analysis of customers, sales, and operations

This list is not exhaustive, and the components can vary depending on the circumstances of the deal. Your focus should be on examining all the crucial details before you make the final decision. 

The Due Diligence Process

When approaching an M&A transaction, follow a due diligence process that will enable you to make an informed decision. This process should include the following steps:

Gathering Information

Start your due diligence process by gathering as much information as possible about the target company. You can obtain information from various sources, including financial statements, tax returns, legal documents, contracts, employee agreements, and customer data. This step aims to get a clear picture of the company’s current state and potential future performance.

Assessing Risks

Once you have acquired the necessary information, assess any potential risks of the M&A transaction. This includes evaluating the target company’s financial health, legal status, competitive landscape, customer base, and more.

Ensure you identify potential problems that could arise, such as legal disputes, hidden liabilities, or regulatory issues. Evaluate the risks based on their potential impact on the transaction and the company’s operations post-merger or acquisition.

Making Informed Decisions

You should base your decisions on a thorough analysis of the information gathered and the risks identified. Consider the transaction’s potential impact on your company’s operations, employees, and stakeholders.

It is also essential to consider the potential benefits of the M&A deal and how it would enhance your company’s operations. This is an excellent time to involve experts who can help you weigh the risks against the benefits. Professionals experienced in M&A transactions can help you determine if it is in the best interest of your company.

Manage Your Due Diligence Process in One Place

Make informed business decisions before the daunting task of due diligence. Say goodbye to time-consuming phone calls and meetings and hello to a streamlined and efficient process with Devensoft. With our custom due diligence request list and real-time responses, you’ll have all the critical information you need in one place, allowing you to focus on what really matters – closing the deal. Devensoft makes it easy to request and receive critical information from the target in one place. You can use the tool to create a custom due diligence request list. You will get real-time responses and updates, making the due diligence process smoother and more efficient.

Schedule your free demo today to learn how Devensoft can help you simplify the due diligence process.