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Due Diligence in Mergers and Acquisitions Transactions

Ashish M. Shaji

| Updated: Jan 02, 2021 | Category: Due Diligence

Due Diligence in Mergers and Acquisitions Transactions

Due diligence is the process of investigating or audit of a deal or investment opportunity that helps a buyer with the assurance of what they buy. It is a process of investigating any business or person before signing the contract. In this article, we shall look at Due Diligence in Mergers and Acquisitions (M&A).

Why is the Due Diligence process essential in the Merger and Acquisitions?

It is an essential aspect of M&A transactions as it allows the buyer to get a sniff of the real business aspects that they are interested to purchase. The Due Diligence process helps buyers in understanding different synergies, growth potential, and allows them to get their hands on more customers.

With an adequate due diligence process, buyers can maximize their revenue generation opportunities and also minimize their loss areas. The due diligence process benefits not just the buyer but also the seller. It allows the seller to detect potential value detractors that help them to gain the confidence of the buyer.

Benefits of Due Diligence in Mergers and Acquisitions Transactions

The process of Due Diligence allows the buyer to have detailed information regarding the target firm and also helps in adjusting themselves as per the expectations of the target firm. Adequate Due diligence in mergers and acquisitions transactions helps the acquirer to protect themselves from potential risks that can arise during transactions. This process is also beneficial in putting practical steps and efficient planning for the proper functioning of the integration process. Due diligence also allows in building a great rapport between the buyer and the target company.

The other benefits of due diligence can be summed as under:

other benefits of due diligence
  • Helps in assessing risks as well as opportunities that is there in the proposed transactions. It, therefore, reduces the unpleasant risk post transaction.
  • Confirms material facts of business and that business is the same as it appears that means without any discrepancy.
  • Helps in identifying potential defects in the target business, thus avoiding bad business transactions.
  • Helps in gaining information that is useful for the valuation of assets and indemnification.
  • Helps in verifying that the target business is complying with the norms of the industry.

Elements of Due Diligence in Mergers and Acquisitions Transactions

 A comprehensive program of due diligence shall review and analyse many key aspects of the business. These areas include the following:

  • Commercial Due Diligence;
  • Legal Due Diligence;
  • Financial Due Diligence;
  • Management Due Diligence[1]
  • Other.

Commercial Due Diligence (CDD)-

CDD seeks to understand the sellers’ commercial prospects depending upon a detailed analysis of the business of the company. Such review provides the purchaser with an insight to the credibility of the forecasts of the company.

Legal Due Diligence-

The scope and the emphasis of this form of due diligence shall depend on the specifics of the sellers’ business and the areas of legal risk that is identified by the buyer and the legal advisor. There are certain common areas of legal due diligence that applies to the majority of the companies. It includes reviewing corporate documents, key contracts, employment agreements, regulatory compliances, insurance certificates, and claims history.

Financial Due Diligence-

The role of this form of Due Diligence in mergers and acquisitions transactions is to provide the acquirer with comfort about the integrity of the financial information provided by the seller. The financial DD team shall, at the beginning of the process, seek a range of information and material from the seller.

Management Due Diligence-

An acquirer shall conduct a review of the company’s management team to determine the strength and weakness. Another consideration would be trying to assess the corporate culture within the seller’s business.

Other

Apart from the standard areas of DD specified above, in certain transactions, additional specialist DD report may be required.

Due Diligence in Mergers and Acquisitions Transactions- Checklist

The checklist is as follows:

Due Diligence in Mergers and Acquisitions Transactions
  • Corporate documentation

Prior to merging with other firm, it is necessary that the legal structure of the target company should be well examined and understood. The buyer is required to inspect the corporate records, Certificate of Incorporation, minute books, etc., for a smooth transition.

  • Financial documentation and data

Financial due diligence is essential for determining the financial benefit that a company can reap from acquisition. As stated above, it helps in identifying the present financial situation and profitability of the target company.

  • Information on customers

Prior to buying or merging with business, the buyer should note the possible effects of merger upon their old and new customers.

  • Historic/Current legal issues

The legal team of the buyer is required to get information on legal cases that could be pending against the seller.

  • Employees and departments

The DD process involves determining the employment agreements of both employers and employees to ensure that none of the agreements is triggered with change in control.

  • Property

During the process, the seller is required to provide complete list of tangible as well as intangible assets to the buyer. The buyer is required to make a thorough analysis of the bills etc. and all the relevant contracts that are associated to the assets of the business.

  • Culture and Legal Due Diligence

A company that mergers with another company ensure that there is a balance of corporate culture in the organization. An efficient due diligence is required for ensuring a hassle free working environment. Legal due diligence evaluates the legal position of the target company. With legal DD, buyers can determine risks and ownership associated with the assets of the larger firms.

Due Diligence in Mergers and Acquisitions: Cases of Inadequate Due Diligence

An inadequate Due Diligence in mergers and acquisitions transactions may leave an inedible impact on the organization. It may harm the reputation of the company for a long time. There have been numerous cases where inadequate DD has affected the company. Below we have provided some of the cases.

  • HP and Autonomy

In the year 2011, Hp acquired autonomy, a data analytics company of Europe. However, later it was found that Autonomy had cooked their books that resulted in the price increase at the time of acquisition. The company could not gain anything from the acquisition. 

  • Ebay and Skype

With a view to diversify their business, ebay acquired Skype in 2005, but many of their users didn’t find any reason to communicate through Skype. It resulted in change of the management of Skype numerous times and piled on losses.

Conclusion


A comprehensive due diligence is essential for the success of the merger and acquisition transaction. The primary objective of Due Diligence in mergers and acquisitions transactions is to validate assumptions on the valuation of risks.

Read our article:Types of Due Diligence Services and Benefits

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Ashish M. Shaji

Ashish M. Shaji has done his graduation in law (BA. LLB) from CCS University. He has keen interests in doing extensive research and writing on legal subjects especially on criminal and corporate law. He is a creative thinker and has a great interest in exploring legal subjects.

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