WHAT IS DUE DILIGENCE?
Due diligence is a process of verification, investigation, or audit of a potential deal or investment opportunity to confirm all facts, financial information, and to verify anything else that was brought up during an M&A deal or investment process. Due diligence is completed before a deal closes to provide the buyer with an assurance of what they’re getting.
Importance of Due Diligence
Transactions that undergo a due diligence process offer higher chances of success. Due diligence contributes to making informed decisions by enhancing the quality of information available to decision makers.
From a buyer’s perspective
Due diligence allows the buyer to feel more comfortable that his or her expectations regarding the transaction are correct. In mergers and acquisitions (M&A), purchasing a business without doing due diligence substantially increases the risk to the purchaser.
From a seller’s perspective
Due diligence is conducted to provide the purchaser with trust. However, due diligence may also benefit the seller, as going through the rigorous financial examination may, in fact, reveal that the fair market value of the seller is more than what was initially thought to be the case. Therefore, it is not uncommon for sellers to prepare due diligence reports themselves prior to potential transactions.
Reasons For Due Diligence
There are several reasons why due diligence is conducted:
Costs of Due Diligence
The costs of undergoing a due diligence process depend on the scope and duration of the effort, which depends heavily on the complexity of the target company. Costs associated with due diligence are an easily justifiable expense compared to the risks associated with failing to conduct due diligence. Parties involved in the deal determine who bears the expense of due diligence. Both buyer and seller typically pay for their own team of investment bankers, accountants, attorneys, and other consulting personnel.
Why Due Diligence Matters
"Due diligence helps investors and companies understand the nature of a deal, the risks involved, and whether the deal fits with their portfolio. Essentially, undergoing due diligence is like doing “homework” on a potential deal and is essential to informed investment decisions"
Due Diligence Activities in an M&A Transaction
There is an exhaustive list of possible due diligence questions to be addressed. Additional questions may be required for industry-specific M&A deals while fewer questions may be required for smaller transactions. Below are typical due diligence questions addressed in an M&A transaction:
1. Target Company Overview
Understanding why the owners of the company are selling the business –
Examining historical financial statements and related financial metrics, with future projections
The quality of the company’s technology and intellectual property
4. Strategic Fit
How the company will fit into the buyer’s organisation
5. Target Base
The company’s target consumer base and the sales pipeline
The company’s management, employee base, and corporate structure
7. Legal Issues
Pending, threatened, or settled litigation
8. Information Technology
Capacity, systems in place, outsourcing agreements, and recovery plan of company’s IT
9. Corporate Matters
Review of organisational documents and corporate records
10. Environmental Issues
Environmental issues that the company faces and how it may affect the company
11. Production Capabilities
Review of the company’s production-related matters
12. Marketing Strategies
Understanding the company’s marketing strategies and arrangements