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A merger or acquisition is the most significant corporate transaction that any business will undertake. Therefore, due diligence is an essential component in this process that must be considered. Due diligence in commercial transactions is an audit or investigation of a potential investment to confirm facts that may directly impact a buyer’s decision to merge or purchase. The need to carry out a due diligence exercise stems from the legal concept of “caveat emptor,” which means let the buyer beware. Hence, whenever anyone wishes to acquire another company or business, as a buyer, he is expected to examine the various aspects of the company or business he wishes to acquire.
During the due diligence process, research ensures that all the facts pan out before entering into a financial transaction or agreement with another party. This research could either be general due diligence relating to finances or legal due diligence regarding compliance with the law and verification of title to the assets, or commercial due diligence to assess future performance. The requirement level of due diligence could vary according to the persons who wish to carry out the due diligence and depending upon the purpose for which it is needed. In addition, the scope and intensity of the exercise will require that due diligence be adapted to the size and importance of the transactions and the human resources available to each party. Hence, tackling due diligence during an M&A transaction is overwhelming, but it is essential for closing a successful, fair, and efficient deal. In this article, we shall discuss the checklist to be noted while conducting due diligence in an M&A transaction.
DUE DILIGENCE CHECKLIST
Choosing the right due diligence approach and tackling an M&A due diligence checklist are the first steps in tackling mergers or acquisitions. A due diligence checklist embodies all the necessary information a company must acquire from its target company before moving forward with a deal. While selling in any industry, the buyer must collect accurate and comprehensive information on the target company because it is the only way to ensure a valuable deal. Therefore, potential buyers are expected to collect documents that give insight into the target company’s corporate structure and documents regarding taxes, strategic fit, intellectual property, material assets, contracts, members, and litigation.
Below is the list of items that should be on every M&A due diligence checklist:
Financial due diligence includes a target company’s revenue, profits, financial assets, and risks. This part of due diligence gives potential buyers a better understanding of a company’s market value. It also offers potential buyers a look at the company’s financial stability and growth capacity. Most importantly, to determine whether the company has the capital to continue operating through the acquisition. The buyer of the company or business should ask for a full report of the financial statement and metrics for the target company’s past, present, and future. Some of these documents include the following:
This aspect of due diligence covers the legal matters facing a company and related risks around contracts and litigation. It significantly affects how or if a deal will move forward because issues like restrictive or breached contracts and past or pending litigation influence the deal’s structure. In addition, legal risks are collected and assessed to gain insight into a company’s legitimacy and viability. The area also focuses on the company and its relationships with its stakeholders. This area includes
This aspect of due diligence enables the potential acquirer to better understand the target company’s commercial soundness and appeal. It gives an assessment of the market and the target company’s potential. It examines the target’s ecosystem to determine its place in the market. This report often includes top customers, competitors, trends, market conditions, and commercial policies. Some additional areas it covers include:
Operational due diligence scrutinizes the target company’s systems and processes to identify risks arising from the execution of the business function. The buyer assesses the effectiveness of the target’s operating model to determine gaps and potential areas where investment or development is needed. This operating model includes sales, marketing, technology, supply chain, and production. Essentially, it looks at how the company turns inputs into outputs. The goal is to see if the current operations can support the business plan provided by the target company. It includes:
This research covers the tax profile of the target company by analyzing tax returns and the company’s tax structure. It provides extensive documentation on their tax history to prove their legality, legitimacy, and viability. This is a highly emphasized area of due diligence, as poor due diligence will cause the buyer to be liable for any tax issues. It also looks at how a merger would affect the tax liabilities of the new entity created by the transaction. It includes:
The above lists are not exhaustive as the due diligence exercise differs by transaction, but there are specific steps that are common to each deal. Generally, the more complex the sale, the more due diligence will be required. Other notable areas requiring due diligence include the target company’s Human Resources, Employment, and Intellectual Property.
CONCLUSION
The importance of thorough and robust due diligence during any M&A activity cannot be over-emphasized. Due diligence is vital in accurately determining value in any M&A scenario. In addition, the correct data and insights can help all parties make better decisions based on a thorough understanding of the full range of risks and opportunities.
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Written by Chiamaka Anyanwu for The Trusted Advisors
Email us: info@trustedadvisorslaw.com