As discussed in an earlier blog, due diligence is a crucially important step before contracting, and will help the parties determine whether or not to proceed with a proposed transaction. This article discusses due diligence in the particular context of merger and acquisition (M&A) agreements.
Importance of Due Diligence in Mergers and Acquisitions
An effective due diligence process will help sellers maximize their profits and buyers best understand what they are purchasing and any risks and potential liabilities that accompany the deal and enable a more realistic valuation. Due diligence in M&A transactions is particularly important in acquisitions of private companies, in which the seller has not been subject to the scrutiny of public markets.
If done well on both sides, the buyer also will appreciate certain intangibles that will be crucial for its ongoing operations, such as understanding how the business and its managers operate; synergies and potential scalability of the business; the firm’s customer base; and ways in which overall operating expenses can be reduced to increase profitability.
The Role of Sellers in M&A Due Diligence
Many think of due diligence as the exclusive province of the purchaser, but the seller has an important role in the process, as well—and it is a role that should begin well before a seller undertakes any effort to sell the business.
Prospective sellers should conduct a business preparedness assessment, which will identify potential liabilities and other value-detractors in the business, which can be addressed before undertaking any meaningful efforts to sell. Sellers also must guide the preparation of key documents, business plans, growth plans, and overall preparation for the M&A process.
Business owners who effectively perform these roles before selling their companies enjoy a significantly higher success rate.
The Role of Buyers in M&A Due Diligence
Parts of the due diligence process will take place at the seller’s facilities, and much of it will be done via a data room—a cloud-based centralized file sharing system set up by the seller or the buyer where data is stored and organized for review. The material in the data room is usually a compilation of information requested by the buyer. The data may be organized by financials, business plan, legal and compliance documents, growth plan, management presentations, etc.
What Types of Inquiries are Involved in M&A Due Diligence?
Typical due diligence questions addressed in an M&A transaction include the following (please also consult our earlier blog):
The information provided under CTA is not publicly available and not subject to the Freedom of Information Act. Such information can be disclosed only to the following governmental entities:
- Target Company Overview, including why the owner is seeking to sell, whether there have been earlier efforts to sell the company, the business plan and long-term strategic goals of the company, how complex is the company (e.g., products, services, subsidiaries), any recent mergers or acquisitions, and the structure of the company.
- Financials, including whether financial statements are audited, what financial statements imply about the company’s financial condition and performance, whether margins are increasing or decreasing, the amount of working capital to run the company, the current capital expenditures and investments, outstanding debt amount and terms, and sufficiency of financial resources to cover the transaction costs of the deal.
- Intellectual Property and Trade Secrets, including what patents and trademarks the company holds, what copyrighted products or materials the company uses, and how and which trade secrets are preserved.
- Strategic Fit, including synergies to be obtained by the transaction, what products or services will be acquired that the buyer does not already have, redundancies, and the overall strategic fit.
- Target Base, including the company’s top customers, any warranty issues or customer backlog, and any other consumer risks facing the seller.
- Management/Workforce, including the compensation and benefit structure for officers, directors, and employees, management incentives and bonuses, employee manuals and policies, and detailed background on C-suite officers.
- Legal and Compliance Issues, including the nature and terms of pending, threatened, and settled litigation, information about the seller’s adherence to regulatory compliance requirements, and any citations and notices received from government agencies.
- Information Technology, including what software packages are currently being used, annual IT maintenance costs, capacity of the usage level of existing systems, the nature and sufficiency of existing security systems, and whether there is a disaster recovery plan in place.
- Corporate Matters, including charter documents, the current officers, directors, and security holders, any subsidiaries, current stockholders and voting agreements, whether securities were properly issued in compliance with applicable laws, and any recapitalization or restructuring documents.
- Environmental Issues, including any hazardous substances used in the seller’s operations, any environmental permits, claims, or investigations related to the company, and any contractual obligations related to environmental issues.
- Production Capabilities, including the most significant subcontractors, largest suppliers, monthly manufacturing yield, materials used in the production process, and any agreements related to the testing of company products.
- Marketing Strategies, including any franchise agreements, current marketing strategies, and any sales representative, distributor, or agency agreements.
Due Diligence ChallengesParties to a deal may confront numerous challenges in the due diligence process, including not knowing what questions to ask/materials to review in a particular transaction; delays in execution of the due diligence process; lack of effective communication between parties, which can create friction; lack of expertise in carrying out some aspects of due diligence; and keeping costs under control while ensuring an effective and efficient due diligence process. Effective counsel can assist in all of these areas. Let Us HelpThe team at Lex Moderna has significant experience in due diligence in M&A deals on both the seller and buyer side. Contact us so we can work with you to bring your sale or purchase to fruition at the best price and under the most favorable terms.