Whether hostile or friendly, mergers and acquisitions (M&As) are a trademark of the business world. These big deals often garner media attention and can take months–even years–to complete. An M&A can cost billions of dollars, depending on the parties and assets involved.
According to Statista, “As of December 2022, the acquisition of Mannesmann AG [a German manufacturing company] by Vodafone Air Touch PLC [an American telecommunications company and predecessor of what became Verizon Wireless after a series of subsequent mergers] in 1999 was the largest all-time merger and acquisition (M&A) deal with transaction value amounting to 202.8 billion U.S. dollars.”
Some quick math on the Federal Reserve Bank of Minneapolis’ Inflation Calculator estimates that this deal would now be valued at over $382.8 billion. It can be dizzying to even think about that sum, let alone imagine the due diligence process and manual administrative burden of sealing such a deal, especially with the tech available in the nineties.
In today’s modern business world, what does the M&A process look like in terms of conducting due diligence? We can’t sugarcoat it—it’s still very complicated. However, following a checklist and getting the right tools on your side can mitigate risks, reduce friction, and contribute to the mutual profitability of any merger.
Let’s break down the M&A due diligence process. First, though, let’s highlight the importance of due diligence and sort out which parties are responsible.
In an M&A deal, the buyer is typically the one doing the most vigorous due diligence research with the goal of ascertaining the true financial position of the company and discerning whether or not an acquisition would be profitable. That being said, M&A due diligence is not limited to the buyer.
“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’s company is more than what was initially thought to be the case,” says the Corporate Finance Institute. “Therefore, it is not uncommon for sellers to prepare due diligence reports themselves prior to potential transactions.”
In the case of a merger, due diligence is especially critical for both parties involved because each needs to be fully aware of the state of each other’s financial situation and operations before moving forward with a merger. As with any viable relationship, there should be transparency, compatibility, good communication, and a willingness to compromise.
Due diligence is a crucial phase in the M&A process that allows both parties to collect data, uncover the facts, assess the value of the deal from a legal and financial perspective, and decide whether or not it’s worth pursuing further.
Conducting thorough M&A due diligence not only works to protect companies from entering into an unprofitable deal but also mitigates the risks of legal repercussions and litigation.
How can merging parties or companies planning to acquire another demonstrate due diligence when navigating the complex M&A process?
A Comprehensive Checklist for M&A Due Diligence
Once you’ve reached the M&A due diligence stage, you’ve already ticked some major boxes in the M&A process, but now it’s time to get down to the nitty-gritty. Gear up to do some digging and make some spreadsheets.
Here are five critical areas for M&A due diligence and questions to answer before moving forward with a deal:
Legal Due Diligence
Buyers should investigate every nook and cranny of a company’s legal status to identify weak spots. The goal is to verify that every aspect of the firm is operating in compliance with legal requirements.
“Legal due diligence entails an in-depth investigation of the target company’s current and historical legal status,” says global law firm Foley & Lardner LLP. “It involves evaluating legal structures, ownership, securities laws compliance, stockholder agreements, management, and its authorities to enter into the transaction. Material contracts, agreements, and obligations should go through a thorough due diligence process to identify any potential liabilities.”
Questions to answer include:
- Are there any red flags signaling potential fraud or non-compliance?
- Are there any authorizations from regulatory bodies necessary to approve this deal?
- Is there any current or past litigation against the company, and is there any potential for messy post-merger lawsuits?
- Does the company own any trademarks, patents, intellectual property, trade secrets, or other assets that must be legally acquired?
- Is the company operating in compliance with any relevant regulations, such as environmental or trade regulations?
- Does the company have any binding contracts or obligations to other firms or stakeholders?
Financial & Tax Due Diligence
Analyzing financial statements and understanding a company’s financial position is foundational to the M&A due diligence process.
“Financial due diligence audits a company’s financial statements and books to make sure that there are no irregularities and that the company is on solid financial footing,” says Investopedia. “Tax due diligence looks at the company’s tax exposure, whether it may owe any back taxes, and where it can reduce its tax burden going forward.”
Questions to answer include:
- Have the company’s financial and tax documents been audited by a third party?
- What do trends from the financial documents (balance sheets, cash flow statements, profit & loss reports, payroll, etc.) reveal about the firm’s financial position and prospects?
- What are the company’s assets and liabilities?
- Have realistic financial projections been made?
- Does the company’s IT landscape, properties, or other aspects need significant upgrades?
- How is the company’s budget allocated?
- Who are the current customers and competitors in the market?
- What products and services does the company offer, and what are the pricing models?
- What are the operational costs?
- What is being done to market the company’s products and services?
- How are employees compensated, and what benefits do they receive?
Cyber Due Diligence
Lack of cybersecurity can be a severe liability for firms. When conducting M&A due diligence, buyers and sellers must prioritize data security and ensure that regulations are being followed.
“Cyber due diligence involves identifying and addressing cyber risks across a company’s information and data network,” explains Forbes. “Cyber due diligence helps determine if the business is adhering to the strict compliance and regulatory requirements when it comes to handling and protecting its data. This should include assessing the safe transfer of data in the case of an M&A.”
Questions to answer include:
- Are there any relevant data laws governing how sensitive data–including employee and customer data–can be shared between the two companies?
- Is the company’s website GDPR compliant, and do they have comprehensive privacy policies and terms and conditions?
- How does the company process, store, and handle customer data?
- What is the company’s current IT landscape? Has it invested in cybersecurity?
Operational Due Diligence
Even if the numbers add up and a company seems to be operating in compliance with the authorities, an M&A can still fail if the two parties don’t take time to conduct operational due diligence.
“Operational due diligence provides significant advantages,” advises the Institute for Mergers, Acquisitions & Alliances. “A true understanding of the business and an early grasp of short-term value levers leads to more benefits realized faster. Looking below the surface is the key to making sure the soon-to-be purchased company provides tangible short-term synergies and quick-win improvements.”
Questions to answer include:
- Who are the current executives, and what will a merger look like?
- What are the standard operational procedures, and how will they mesh?
- What plan and capital are in place to successfully merge the operations of the two companies?
- How will various departments (sales, purchasing, marketing, compliance, etc.) unite for an improved bottom line?
Cultural Due Diligence
Companies that go above and beyond to address M&A due diligence in the aspect of company culture are more likely to have a successful merger, avoiding disgruntled employees and talent retention issues.
“Cultural due diligence is crucial because it helps identify potential cultural clashes and integration challenges that could undermine the success of a merger or acquisition,” says the M&A Leadership Council. “By understanding the cultural differences and similarities between the merging organizations, companies can develop strategies to align cultures, foster collaboration, and minimize integration risks, ultimately improving the chances of a successful merger or acquisition.”
Questions to answer include:
- What reputation does the company have in its industry, and what is the public’s perception?
- What are the company’s brand, cultural values, and ethics, and are they compatible?
- What will be done to ensure that both workforces can unite effectively?
- What measures will be taken to manage public relations throughout the M&A process?
- What training, monitoring, and resources will be directed toward aligning the company’s post-merger culture?
M&A Due Diligence Software – How Virtual Data Rooms Promote Success
M&A due diligence is a painstaking process, but it pays for itself in the end – whether by saving you from the losses of an unprofitable M&A or by helping you identify a worthwhile investment and acting as a map to a successful merger.
Each of the above aspects of M&A due diligence requires a vast amount of data collection, analysis, and collaboration. Both buyers and sellers stand to benefit greatly from leveraging M&A due diligence software.
CapLinked offers cutting-edge M&A due diligence software to help you navigate the complexities of a merger or acquisition. Our virtual data rooms (VDRs) give you an ultra-secure, user-friendly portal for organizing, storing, and accessing all of the information you collect during the M&A due diligence process while giving you a transparent and centralized location for collaboration as you calculate your next move.
“For all transactions, the objective of due diligence is to assist a buyer in determining whether to acquire a target, if so, for how much, and to allow the buyer to ascertain the target’s risks, potential combination benefits, and overall strategic fit,” says the Institute of Mergers, Acquisitions & Alliances. “To help a buyer answer these questions, information related to a target company are made available in a data room during the due diligence stage of a transaction. Thus, the data room is an integral part of the due diligence process.”
Get the power of virtual data rooms on your side. Try our M&A due diligence software for free to see how it can help pave the way to success on your next merger or acquisition.
