Understanding Due Diligence in Mergers and Acquisitions

Mergers and acquisitions (M&A) can position your company for significant growth in several ways. Through M&A, your business can access technological improvements, a broader client base, and new expertise and leadership from teams who align with your values and mission.

Due diligence is a mandatory process for successful, lawful mergers and acquisitions. A comprehensive due diligence procedure is crucial in avoiding financial or reputational risk for your company.

The best due diligence procedures will closely analyse the M&A transaction in several essential steps. In this article, we’ll characterise due diligence in M&A, explaining the necessary steps in the process and modern best practices to overcome challenges in due diligence.

Defining Due Diligence in M&A

What is due diligence in mergers and acquisitions? Due diligence in M&A is the comprehensive analysis of the factors influencing the M&A valuation, risks, and benefits of the company being acquired or merged with. Some examples include investigations into a company’s economic standing and assessing the culture fit between employees of both companies.

There are differing philosophies regarding due diligence in mergers and acquisitions. Because of the time and cost of a thorough M&A due diligence process, some companies may perform an accelerated, high-level analysis seeking only the most glaring defects and irreversible flaws in the potential seller.

However, it’s recommended to have a more extensive process to identify M&A risks that could affect not only the short-term but the long-term health of your business. Therefore, a satisfactory due diligence process in M&A examines the company’s financial properties while also including thoughtful legal consideration and a full operational review.

Financial Assessment in M&A Due Diligence

A thorough financial evaluation in M&A can produce invaluable information. The financial risks, rewards, and liabilities should all face intense scrutiny in this crucial step of the due diligence phase.

The following examples detail how an extensive financial performance assessment informs the M&A process.

• QofE reporting – When examining a company's financial history, the Quality of Earnings (QofE) financial report is often a helpful tool for negotiations. This report collects the target company’s past earnings while omitting one-time events, giving a reliable perspective on the company’s normalised income.
  
  
• Interviews with financial management – Talking to both the internal financial professionals at the company and the external financial auditors can give a more precise representation of the financial health of the business you are negotiating with.

• Perform projections – Understanding the target company’s prediction of how their business will grow is vital to the financial due diligence process. However, it’s also helpful to perform your own projections to compare against the target company’s—this ensures both parties have a realistic, well-aligned vision of their financial future.

When performing financial due diligence, it’s vital to assess a company’s finances from all angles: past, present, and future. Carefully scrutinise both one-time financial events as well as regular earnings to understand how the company works financially, and you will be one step closer to completing your M&A due diligence process.

Legal Considerations During Due Diligence

Lawyers play an equally important role in the due diligence procedure for mergers and acquisitions. A complete legal exploration of a target company can benefit your M&A due diligence process in the following ways.

• Verification of IP, legal status, and more – The acquirer’s legal team should fully summarise the target company’s IP portfolio, patents, trade secrets, and current and past legal statuses, including pending litigations to see if there are any potential issues. Verifying these licences and properties ensures a company is operating within the law and that its reported financial information is accurate.
  
  
• Overall deal structure – Legal is responsible for the draft of the acquisition agreement. Their due diligence process will inform the terms and clauses, such as any transitions of services, debt adjustments, and anything else involved in an M&A strategy.

Legal evaluation can be just as critical as financial performance evaluation in the due diligence process because legal discoveries can inform the valuation of a target company.

Operational Due Diligence in M&A

Operational due diligence involves closely examining how different teams within the target company function. For example, you might perform an operational review of the marketing team to see if there are any needs for restructuring or issues that may impact future performance or growth.

An adequate operational review can illuminate weaknesses and strengths within the target company’s divisions. It can also uncover the need for streamlined processes or better use of technology to make teams more efficient.

HR Due Diligence

HR due diligence focuses on the workforce and organisational culture of the target company and helps to align company culture with that of the acquiring company.

Specifically, HR due diligence looks at employee relations, identifies key personnel and potential retention issues, and evaluates cultural compatibility. It ensures that the workforce transition is as smooth as possible, preserving the human capital that is essential to business success.

Best Practices for Effective Due Diligence

Beyond financial, legal, and operational due diligence considerations, there are additional best practices to strive for when performing your M&A deal checklist.

• Tax due diligence – All angles of a company’s tax status should be investigated, including incomes within additional countries, payroll, and available tax attributes.
  
  
• Technology diligence – When the diligence team of the acquiring company performs its analysis, it should strive to determine if the acquired company’s technological standards meet its own. For example, is the target company’s network secure? Do they meet modern cybersecurity standards?

• Reputational diligence – It may seem like common sense, but it’s vital to evaluate the target company’s reputation before any merger or acquisition. Uncovering charges of fraud or labour law violations, for example, could significantly impact negotiations or M&A valuation methods.

Navigating a merger or acquisition while adhering to best due diligence practices can be extremely taxing. A global HR partner like Omnipresent can lift much of that burden off your team and give you the confidence to navigate mergers and acquisitions from a more advantageous, more informed position.