What Exactly Is a Due Diligence Review?
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 completing a financial transaction or an agreement with another party.
In a corporate acquisition, due diligence typically involves fully understanding a company’s obligations, such as debts, leases, distribution agreements, pending and potential litigation, long-term customer agreements, warranties, compensation agreements, employment contracts, and similar business components.
Mergers and acquisitions are usually associated with extensive due diligence by the buyer. Before engaging in the transaction, the buyer wants to ensure they know what they are buying, what obligations they are assuming, and to be informed about the nature and extent of the seller’s contingent liabilities, problematic contracts, litigation risks, intellectual property issues, and much more. In this process, special and increasing consideration is given to IT, as it is comprehensively embedded in all business areas and processes. In a so-called IT due diligence review, the existing IT (hardware, software, networks, resources, processes, locations, projects, etc.) and the data protection organization of a company are systematically examined and evaluated. A thorough examination is particularly essential for the acquisition of private companies, where the seller is not subject to public market scrutiny.
Recent MA activities and litigation have made it clear that a buyer must conduct thorough due diligence with regard to potential risks, particularly when examining financial statements, data protection and cybersecurity issues, existing IT, intellectual property matters, and potential employment law obligations.
What Steps Should Be Considered in Due Diligence?
Due to the complexity of mergers and acquisitions, the due diligence review can take several weeks to several months. The first step in the process is to assemble a team that will be responsible for conducting the due diligence review.
Appointment of a Due Diligence Team
To ensure that the process is conducted properly, the buyer needs a team of legal and financial experts with specialized knowledge in MA. A due diligence team typically consists of investors, auditors, lawyers, personal advisors, and possibly other service providers, depending on the industry in which the company operates.
The next step in the process is gathering important documents. The due diligence team creates a detailed checklist outlining which documents are needed and in what timeframe 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 company arrange a meeting or series of meetings to discuss the MA process and required documents. During these meetings, both parties can better assess their compatibility, and the buyer can ensure that it is a sound investment.
Required Documents
The exact documents required during the due diligence process can vary depending on the type of company, its size, and similar factors, but there are some types of data that are generally always requested. These typically include company documents, intellectual property contracts, information about shareholders, and a history of legal disputes. The buyer may also request information on regulations, insurance, lease agreements, and other financial information.
Overall, the buyer must form a solid picture of the target company’s financial health, operational assets, legal affairs, and strategic position. If any of the provided information presents a problem, the deal may not proceed.
The next step in the due diligence process is to review all the information provided by the target company. If the buyer has questions about the documents, now is the right time for the target company to address their concerns.
Addressing Potential Buyer Questions and Concerns
If the buyer is unable to find certain answers based on the information provided by the target company for any reason, they may request additional information. There are specific things the due diligence team will look for when reviewing the documents, such as warning signs, known as red flags, that could indicate a potential problem with the company.
During the review, the team determines whether the problems found could lead to the deal being abandoned altogether, or if the offer should be modified. In some cases, 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 clarify any questions or concerns in a timely manner. If the buyer is satisfied with the information received and decides to proceed with the transaction, the final step is to draft a purchase agreement and submit it to the target company for approval.
Final Assessment
A report is attached to the contract that contains a summary of all issues discovered during the due diligence process, as well as areas that were found to be satisfactory. At the end of the report, the buyer makes a final assessment of the deal. If the buyer considers the acquisition to be a solid investment, they will proceed with the transaction as planned.
In some cases, however, the buyer will request an adjustment to the deal based on their findings from the due diligence process. If the problems prove too difficult, the buyer may also cancel the deal entirely.
Why is Due Diligence So Important?
There are many benefits to conducting M due diligence. Firstly, the buyer is better able to adjust their expectations when they carefully examine a company’s individual circumstances. This information can also be useful during negotiations.
When a buyer is able to gather important data about a company, there is less risk of unexpected legal and financial problems. Due diligence is an effective means for buyers to protect themselves against risky deals.
Since due diligence requires a high level of communication between both parties, the companies can also build a working relationship.
Mergers and acquisitions are not always black and white. These complex transactions can be lengthy and often require a long back-and-forth between the buyer and seller before the transaction can be completed. Without due diligence, companies may withhold important information that could ultimately affect the buyer’s decision.
Conclusion
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. Essentially, due diligence is like ‘homework’ that needs to be done on a potential deal and is an essential prerequisite for informed investment decisions.
Through our IT due diligence, we at digatus provide information about strategic, operational, and financial opportunities and risks in IT. This should facilitate the purchase decision, price negotiation, and post-merger integration.
In IT due diligence, we strive to make reliable statements about the IT status early on and find restructuring opportunities. This enables the analysis of the target IT and the creation of realistic business plans.
Christoph Pscherer
He has been working in the IT environment for almost 30 years, gaining experience in various roles and areas. Through his years of experience as a Service Manager, he knows the challenges and needs on the customer side. He has been applying this deep understanding and knowledge at digatus for more than eight years. As Head of BU IT M&A and Transformation, he and his team support all IT topics along the value chain of M&A projects. This includes due diligence, carve-out, and integration projects.
