When it comes to business acquisitions, the significance of the due diligence process can’t be understated. Having prior knowledge about all aspects of your new investment or acquisition will save you from a massive headache in the future. Business due diligence allows you to make an informed decision with all the facts.
In this article we’re going to outline some of the major areas of M&A due diligence.
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Some Common Types of Business Due Diligence
Whether it’s a small business acquisition or a large, multi-million dollar deal, due diligence lets you minimize the associated risks that come with any kind of M&A transaction. It’s a necessary step regardless of whether you’re an individual investor or a group looking for a profitable opportunity.
Proper research and analysis of the business transaction can help you identify any kind of potential or critical problems that might have stayed hidden otherwise. Without this vital step, you might find yourself becoming liable for a series of post-transaction charges.
The areas of focus for business due diligence are different for every transaction, but below are some common types that a business could undertake before finalizing the purchase.
Financial due diligence is one of the most significant steps for any business to take before a transaction. Financial analysis is performed even by companies that don’t follow a formal structure for due diligence because the need for it is just that obvious.
A detailed and thorough examination of a company’s financial performance and documents is undertaken to find any kind of inconsistencies or hidden costs.
For a complete understanding of the company’s position, financial due diligence can use audited financial statements for at least 3 years, the company’s forecasted statements, and detailed information regarding payables. Not only those, but cost and profit analysis, debt to capital, as well as other kinds of common parameters can also be utilized to provide a comprehensive understanding of the company’s financial position.
Commercial due diligence is all about gauging the attractiveness of the company. It provides a complete overview by incorporating both internal and external factors such as market share and positioning.
Commercial due diligence allows you to determine whether the company can meet its commercial targets and just how realistic the goals described within the company’s business plan are. Furthermore, it assists in the proper utilization of Micro-PE.
It’s essential to see the company’s position in the market with regards to its competitors, especially if it’s a small business, and commercial due diligence allows you to do just that.
It’s a critical step that gives you an edge during M&A negotiations by clearly communicating the long-term viability of the company you intend to purchase.
Human Resources (HR)
It might not seem consequential to follow up on a company’s workforce, but any credible due diligence consulting agency would tell you how indispensable it is. A detailed examination of the employment contracts, as well as the number of positions, vacancies, and turnover ratio, can reveal important information regarding the company’s work environment.
Furthermore, a look at the previous, recent, and ongoing legal disputes with existing or former employees can save you from any unpleasant surprises in the future. It’s also a common practice to conduct background checks on the company personnel in top executive positions to get ahead of any unpleasant scenario.
Environmental, Health, and Safety
A decade ago, a company’s green policies would be irrelevant during M&A transactions and business due diligence processes. Now, with regulations regarding sustainable practices on the rise, and a push towards green practices by governments and customers, it has become a significant aspect of a company’s analysis.
Local and international businesses have to ensure compliance with environmental, health, and safety regulations or face exhausting court procedures and hefty fines.
Environmental due diligence can reveal whether the company is compliant with regulation and if it has all the proper permits and licenses to perform operations. If not, then further research about the cost of acquiring these permits can be undertaken, allowing a more accurate evaluation of the company to negotiate with during M&A transactions.
No company can survive without keeping up with the developments of IT and yet, the cost of maintaining a good IT system can be expensive. It’s why many companies fail to have a competent IT structure. In some cases, even companies that spend a considerable amount on the IT infrastructure fail to use it effectively.
With information technology due diligence, you can determine the IT capabilities that the company you intend to acquire has. Most importantly, you can determine how much work you need to put into the IT structure or the departmental processes to ensure smooth operations.
What are the operating systems and applications that the company uses? Can the staff shift to a more demanding software? Is the current equipment and office computers capable of supporting this software? And finally, what is the ownership status of the IT equipment the company uses?
These are all important questions you must ask in detail from the target company.
The importance of legal due diligence doesn’t need to be explained. The company’s articles of association and memorandum must be thoroughly examined. Moreover, a detailed look at the transcripts of board meetings for at least 3 years must be held. It can help determine whether the internal actions of a company corroborate with their financial statement.
Nowadays, many entrepreneurs prefer the searchfund route over starting something from scratch. More stakeholders means more complex legal structures, as you need to abide by partnership rules, maintain conflicts in interests, and reduce liabilities.
Examining any kind of licensing or partnership agreements, as well as loan and bank financing agreements, along with other MOUs can provide you with the necessary legal protection.
Due diligence in regards to the company’s intangible assets is also necessary. A look at their owned patents, copyrights, and trademarks can show how valuable the company is. Furthermore, it’s also important to see if the company is in any legal case because of intellectual property violations.
Taxation is a tricky area, making due diligence for taxes a must. It’s important to review and recalculate the tax liability of a company before acquisition. Even more important is the verification of the company’s status with the proper authorities in regards to their existing and outstanding tax liability.
Tax due diligence requires a comprehensive look into the tax returns of the company and any kind of unique correspondence with the authorities. You’ll never know what you’ll find by taking an in-depth look at the documents.
There’s no point in going forward with an acquisition deal when the company in question doesn’t have a market to operate. That’s exactly what marketing due diligence lets you know.
By examining the company’s market plans and performing SWOT or PESTEL analysis, you can easily determine the growth opportunities for the company and whether it’s a profitable investment or not.
What’s The Next Step?
Now that we’ve talked in detail about business due diligence and its types, it’s time to discuss how to go about the process during the initial days of acquisition.
The intricacies of the actual process are different for every industry and organization. However, you’ll find that broader requirements will be similar in any case. The following sections will outline the 6 important tasks that are common for any due diligence process.
1. Collect All Relevant Documents
No business due diligence process can start without the relevant documents. In most cases, the relevant documents won’t be available to the acquirer until an LOI has been accepted.
After the preliminary discussion regarding M&A, you must outline a framework that includes provisions for and reexamination of the agreement after due diligence has taken place.
The focal point of any discussion regarding due diligence should be the complete availability of confidential documents to undergo thorough scrutiny.
These documents could include the company’s financial statements for at least 3 years, their business plan and future strategy, complete in-depth information regarding sales, expenses, legal matters, and more.
Documents aren’t the only area for examination. It’s critical to inspect buildings, factories, and production facilities if applicable. Furthermore, direct interviews with prominent staff members are also an important source of information.
2. Assemble a Team of Qualified Individuals
Due diligence is a complex and exhausting task. The team you select must be capable of handling the complexity of the task and must have relevant skills. There’s no point in doing financial due diligence if you don’t have an accountant who specializes in such matters.
Similarly, a specialized lawyer needs to inspect the legal aspects of the targeted company. You could also bring in due diligence consultancy firms if finding the right people for the job is proving to be difficult.
Regardless of how much it costs for you to perform business due diligence, you won’t regret spending a little extra cash to save yourself from future hurdles.
3. Understand the Challenges
As stated, due diligence is not an easy process to undertake. It comes with its own unique set of challenges and problems that your team must be ready to face. A major challenge you could face is not knowing the right questions to ask. Each type of business due diligence comes with several documents and aspects of the business.
It can be daunting to keep a track of what questions to ask when you’re bombarded with information.
Another challenge could be the lack of communication between you and the targeted company. Not every company will be on board with you performing due diligence. Many will see it as a waste of time. This approach, in turn, could lead to poor communication and hesitancy, as well as delays to inquiries.
Finally, due diligence is expensive and lengthy. It can potentially postpone the finalization of a deal for months and, depending on what you find during the inspection, might even lead to a cancelation of the deal.
4. Be Insistent
Due diligence requires you to be thorough and to examine any critical inconsistencies between data. If you discover any misrepresentation between what’s written on paper and what you’ve observed, you’ll need to ask a lot of questions until you’re satisfied, regardless of reservations.
Follow your gut. If something doesn’t sit well with you, it might be better to become more cautious of the acquisition.
5. Conduct Different Types of Due Diligence
We’ve talked in detail about the different types of due diligence that you could undertake above. It’s important to understand that during M&A, you have to perform as many business due diligence processes as you can, depending on the size and scale of the company being targeted.
The most important thing, however, is to stay organized and carry out the due diligence process with a systematic approach. Simple things like maintaining a due diligence checklist or creating a formal workflow can help you optimize the entire process.
Due diligence is hard enough when it comes to public companies, but things can get even more complicated if the targeted company is private.
6. Get Ready to Renegotiate
If everything you uncover during due diligence looks right, then you can go ahead with the transaction without any worry — but the probability of this happening is slim.
Depending on the severity of what you uncover, you can rework the negotiations and revalue the business as per your findings, or you might even have to be prepared to retract the initial purchase offer entirely. This is especially likely if the company wasn’t forthcoming with their statements.
You might consider it to be a tremendous loss of money and time, but not investing is better than a bad investment.