What exactly is due diligence?
Due diligence is an examination or investigation of a potential investment to confirm facts that may have a direct impact on the buyer’s decision to merge or make a purchase. During the due diligence process, investigations are conducted to ensure that all facts are correct before entering into a financial transaction or agreement with another party.
In a business acquisition, due diligence typically includes a full understanding of a company’s obligations, such as debt, leases, distribution agreements, pending and potential litigation, long-term customer agreements, warranties, compensation agreements, employment contracts, and similar business components.
Mergers and acquisitions typically involve extensive Due Diligence by the buyer. Before committing to the transaction, the buyer wants to make sure it knows what it is buying and what obligations it is assuming. The buyer also needs to be informed about the nature and extent of the seller’s contingent liabilities, problematic contracts, litigation risks, intellectual property issues, and more. In this process, special and increasing consideration is given to IT, as it is comprehensively embedded in all company divisions and processes. In an IT due diligence audit, the existing IT (hardware, software, networks, resources, processes, locations, projects, etc.) and the data protection organization of a company are systematically examined and assessed. Due diligence is particularly essential for the acquisition of private companies where the seller is not subject to public market scrutiny.
Recent M&A activity and litigation have highlighted the need for a buyer to conduct due diligence with respect to potential risks, particularly in examining financial statements, data privacy and cybersecurity issues, existing IT, intellectual property issues, and potential labor obligations.
What are the steps in due diligence?
Due to the complexity of mergers and acquisitions, due diligence can take several weeks to several months. The first step in the process is to assemble a team that will be responsible for conducting due diligence.
Appoint a due diligence team
To ensure that the process is conducted properly, the buyer will need a team of legal and financial professionals with specialized knowledge of M&A. A due diligence team typically consists of investors, accountants, lawyers, personal advisors, and other service providers, depending on the industry in which the company operates.
The next step in the process is to gather key documents. The due diligence team creates a detailed checklist of what documents are needed and the time frame in which the documents are due. After signing a confidentiality agreement, the due diligence team can then request this information from the target company.
In some cases, the buyer and the target agree to a meeting or series of meetings to discuss the M&A process and the required documents. At these meetings, both parties can better assess their compatibility, and the buyer can make sure it is a sound investment.
Required documents
The exact documents needed during due diligence can vary depending on the type of business, the size of the business, and similar factors, but there are some types of data that are usually requested. These typically include corporate documents, intellectual property contracts, shareholder information, and a history of litigation. The buyer may also request regulatory, insurance, lease, and other financial information.
Overall, the buyer must have a solid picture of the target company’s financial health, operating assets, legal matters, and strategic position. If any of the information provided is a problem, the deal may not go through.
The next step in the due diligence process is to review all the information provided by the target company. If the buyer has any questions about the documents, this is the time for the target company to address its concerns.
Managing questions and concerns of the buyer
If, for some reason, the buyer is unable to find certain answers based on the information provided by the target, the buyer may request additional information. There are certain things the due diligence team will look for when reviewing the documents, such as warning signs, known as red flags, which may indicate a potential problem with the company.
During the review, the team will determine whether the problems found could lead to the business being abandoned altogether or whether the offer should be modified. The information found may also suggest a change in the business structure.
To expedite the process, the due diligence team may hold meetings with the target company to try to resolve any issues or concerns in a timely manner. If the buyer is satisfied with the information obtained and decides to proceed with the transaction, the final step is to draw up a purchase agreement and send it to the target company for approval.
Final evaluation
A report is attached to the contract that summarizes any issues discovered during the due diligence process and any areas that were found to be satisfactory. At the end of the report, the buyer makes a final evaluation of the deal. If the buyer considers the acquisition a sound investment, it will proceed with the transaction as planned.
In some cases, however, the buyer will request an adjustment to the deal based on its due diligence findings. If the issues prove too difficult, the buyer may also abandon the deal altogether.
Why is due diligence so important?
There are many advantages to performing M&A due diligence. One advantage is that the buyer is in a better position to adjust expectations when it closely examines the individual circumstances of a company. This information can also be useful during negotiations.
If a buyer can gather relevant data about a company, there is less risk of unexpected legal and financial problems. Due diligence is an effective way for buyers to protect themselves from risky deals.
In addition, because due diligence requires a significant level of communication between both parties, companies can establish a working relationship.
Mergers and acquisitions are not always black and white. These complex transactions can be lengthy and often require a lot of back and forth between the buyer and seller before the deal can close. Without conducting due diligence, companies may conceal essential information that can impact the buyer’s decision.
Summary
Due diligence helps investors and companies better understand the nature of a deal, the risks involved, and the suitability of the deal for their portfolio. In essence, due diligence is something of a “homework assignment” completed on a potential business and an essential prerequisite for sound investment decisions.
With the help of our IT due diligence review, we at digatus provide information about the strategic, operational, and financial opportunities and risks of IT. This review should facilitate the purchase decision, price negotiation, and post-merger integration.
During the IT due diligence review, we strive to make reliable statements about the IT status at an early stage and to find restructuring opportunities. This review further enables the analysis of the target IT and the preparation of realistic business plans.
