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Due diligence in mergers and acquisition

We will continue the Financial Advisory Series by talking about due diligence in mergers and acquisitions (M&A) this week.


Although the phrases "mergers" and "acquisitions" are sometimes used interchangeably, their meanings are distinct. An acquisition is when one firm buys another entirely. A merger is the coming together of two businesses to establish a new legal entity under a single corporate name. By examining comparable firms in the sector and employing measures, a company may be objectively appraised. Mergers and acquisitions aren't always easy to pull off. In reality, these complex transactions can take a long time to complete and frequently need a significant amount of time between buyer and seller. Companies may fail to disclose crucial facts that might impact a buyer's choice to proceed with a purchase if due diligence is not performed. Due diligence in mergers and acquisitions is an effective approach for purchasers to protect themselves against business risk and losses.

What is due diligence in M&A?

When a firm considers buying another company, it must investigate the target company's market and financial situation to ensure that it does not acquire unanticipated difficulties or overpay.

Due diligence refers to the process of gathering and analysing important information. It is a process of verifying and auditing a possible investment or transaction. It is often performed after a transaction has been agreed upon but before a formal contract is signed. Due diligence helps the buyer to verify essential facts (such as financial accounts, debts, employee contracts, possible or present litigation, and so on), as well as analyse the business's value and any potential risks. This approach aids the client in becoming more knowledgeable so that they may make better decisions.

Importance of due diligence

Due diligence assists investors and businesses in determining the nature of a transaction, the risks involved, and if the transaction is a good match for their portfolio. Due diligence is essentially conducting "research" on a possible acquisition and is critical to making educated investing decisions. Due diligence-processed transactions have a better likelihood of succeeding. Due diligence helps decision-makers to make better judgments by improving the quality of information accessible to them.

  • From the buyer's point of view - Due diligence helps the buyer to feel more certain that their expectations from the deal are accurate. Purchasing a firm without conducting due diligence significantly raises the risk to the buyer in M&A.

  • From the seller's point of view - Due diligence is carried out in order to give the buyer confidence. Due diligence, on the other hand, may benefit the seller, since going through the thorough financial analysis may disclose that the fair market worth of the seller's firm is higher than previously anticipated. As a result, it is usual for sellers to compile their own due diligence studies prior to possible purchases.

Reasons for due diligence

Due diligence is carried out for a variety of reasons:

  • To confirm and verify information presented throughout the transaction or investment process.

  • To spot possible flaws in a contract or investment opportunity in order to prevent a disastrous business agreement.

  • To gather information that will be beneficial in determining the deal's worth.

  • To verify if the transaction or investment offer meets the investment or deal conditions.

Due diligence activities in M&A

There is a long number of potential due diligence questions to consider. For industry-specific M&A agreements, more inquiries may be necessary, but for smaller transactions, fewer questions may be required. In an M&A deal, the following are common due diligence questions:

  • Overview of the target company

    • What is the business plan and long-term strategic objectives of the company?

    • What is the business plan and long-term strategic goals of the company?

    • What is the company's level of complexity (in terms of goods, services, and subsidiaries)?

    • Has the business lately purchased or merged with another?

    • What is the company's geographical structure?

  • Financials - Analysing previous financial records and associated financial measurements, as well as making estimates for the future i.e. future projections.

  • Technology/patents - The company's technology and intellectual property are of good or high quality.

  • Strategic fit - How the firm will integrate within the buyer's organisation on a strategic level.

  • Target consumer base and sales pipeline - The company's target consumer base and sales pipeline.

  • Management/workforce - The management team, employee base, and corporate structure of the organisation.

  • Legal issues

    • Is there any current, threatened, or settled legal action or lawsuit against the company?

    • What are the terms of any resolved litigation, and what is the status?

  • Information technology - Capacity, systems in place, outsourcing agreements, and the company's IT recovery strategy.

  • Business matters - Examining organisational papers and corporate records.

  • Environmental concerns - The firm's environmental concerns and how they may influence the company.

  • Production capabilities - An examination of the company's manufacturing capabilities.

  • Marketing strategies - Understanding the company's marketing plans and arrangements.

In summary, due diligence needs to be conducted to ensure that the buyer knows exactly what they are buying before a deal closes. M& A need extensive due diligence.

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