While we know that the field of merger and acquisition is a tricky one, we do often wonder about the different steps it involves and why there is so much discussion over Due diligence.
Due diligence is an evaluation process used by an interested buyer to better understand the selling business and risks in potentially becoming an owner of that business. The primary goal of due diligence in the M&A process is for the buyer to confirm the seller’s financials, contracts, and customers. Due diligence is a vital activity in M&A transactions and may consume several months of intense analysis.
Importance of due diligence in merger and acquisition process
From a buyer’s perspective, due diligence is essential to understand the way the business, its owners and its management operate. Identifying potential value detractors in the business will be comfortable with the evaluation and it will also prove helpful in assisting in the preparation of critical documents. Lack of planning can lead to a company failing the merger and acquisition process.
Carrying out the due diligence process:
1. Financial Due Diligence: The financial process involves analysis of historical financial statements and related financial metrics, major customer accounts, fixed and variable cost analysis, analysis of profit margins, and examination of internal control procedures as well as the reasonableness of the target’s projections of its future performance.
2. Customers, Sales & Marketing: As customers or clients are the lifeblood of any business, the types of due diligence invariably include a close look at the target company’s customer base. In this process the company must look whether there will be any issues in keeping customers after the acquisition and what are the sales terms or policies.
3. Legal: A legal due diligence covers the legal aspects of Business transaction liabilities of the target company, potential legal pitfalls and other related issues. This usually includes review of key commercial agreements, IP, and contracts.
4.Taxes: Tax due diligence may or may not be critical, depending on the historical operations of the target company, but even for companies that have not incurred historical income tax liabilities, an understanding of any tax carryforwards and their potential benefit to the buyer may be important.
5.Human Resources: In this process the buyer will want to review a number of matters in order to understand the quality of the seller’s management and employee base. It becomes important that members who have vital information about the behavior of the employees or about the overall culture of the organization impart the knowledge to the other organization before a merger or acquisition. Collecting information about skills and talents of different personnel also helps in making long-term strategies. This process is vital because if a cultural conflict exists, the employees will not work to their full potential, intentionally or unintentionally.
Since due diligence helps in understanding synergies, potential scalability of the business by including enhanced operations, thus giving more access to customers from the buyers’ company. Besides that, it is also important to remember that the seller must invest in conducting a business preparedness assessment even before involving with an investment banker.
Therefore, due diligence and should be the primary focus in any merger and acquisition and it will guarantee success. Now, it is clear that due diligence is an essential step in the whole process of merger and acquisition and hence cannot be overlooked.