The 10 Most Common Challenges in Due Diligence

Nothing valuable comes easy.

That’s the logic behind due diligence. In a sense, an in-depth due diligence process should bring challenges. It comes with the territory.

Below, we look at some of the challenges that DealRoom has witnessed across hundreds of M&A transactions over the years.

1. Not knowing what questions to ask

It pays to prepare for due diligence well before the process has started to give your company the best chance of asking the right questions.

By the ‘right questions,’ we mean asking the questions that get to the nub of the matter.

A good start here is using the DealRoom templates developed for each kind of due diligence, based on the feedback gained from thousands of M&A professionals. But each deal will throw up its own specific set of questions. 

2. Inadequate technology

Too many due diligence teams have become accustomed to using spreadsheets and email in the due diligence process. This only serves to slow up the process that is already costing by the hour.

The most sophisticated due diligence tools - such as DealRoom - enable teams to exchange information in a more organized and secure way, with none of the laborious email trails that characterized due diligence processes in the past.

The ‘request’ feature at DealRoom is a unique function that streamlines the process even further.

3. Poor communication

It’s all too easy for the various teams in due diligence (operations, finance, legal, etc.) to work in silos without ever touching base with the other teams.

But this is just one communication shortcoming that dogs due diligence. There’s also the issue of communicating properly with the other side of the transaction, and providing transparency to everyone involved in the process.

All of this is better achieved by inviting all relevant participants into the virtual deal room - allowing them to gain insight into how every step of due diligence is progressing.

Here is an example how communication can be done in DealRoom requests.

4. Slowness of execution

There’s an informal saying in due diligence that “everything that drags gets dirty,” the implication being that the longer due diligence goes on, the more likely things are to become sour between the buyer and seller.

While there is some element of truth to this, the goal of due diligence is to provide complete information - not to provide whatever information becomes available in a predefined period of time.

This slowness of diligence execution will create challenges of motivation for managers on both sides of the transaction.

5. Unplanned costs

The trick with due diligence is to view it as an investment rather than a cost. Although it can seem that due diligence is expensive - and even more so when unforeseen costs arise - the costs of an extra month or two of due diligence are minimal when compared to those that come with buying the wrong company.

For this reason, it pays to change your perspective on due diligence from being an operating cost to an investment cost - one which will either lead to a successful acquisition or save your company from making a bad one.

6. Lack of expertise

A major challenge of due diligence is knowing what your in-house due diligence team can and cannot do, and then finding the right people to bridge those gaps.

A regular accountant, for example, is unlikely to be able to provide the kind of analysis required for a deep-drive into the target firm’s financials.

Of course, it could well be within the capabilities of your CFO, but you’ll need them to be honest about their capabilities, as a lack of expertise in any part of due diligence can prove to be highly expensive further down the line.

7. Team buy-in

The post-merger period has the potential to create a level of discontent among insecure employees, ahd the pre-merger period, most of which is occupied by due diligence - also has this potential to create disillusionment, albeit to a lesser extent.

You may find yourself having to convince members of the due diligence team of the benefits of the merger to them in their careers. That being said, it’s equally important to listen to what they’re saying.

If they see gaping holes in the target company’s story during due diligence, it should not be overlooked.

8. Incomplete information

Incomplete information is a common challenge of due diligence and it does not necessarily mean that the seller is being opaque.

It could be a case of bad record keeping or simply an inability to access the information that your due diligence team is requesting.

Assuming you believe the gap in information is not deliberate obstruction of your investigation into the business, the task then becomes making a decision with the information you have. 

9. Sunk Costs

Why do sunk costs represent a challenge in due diligence?

Because all too often the participants in deals go ahead with deals on the basis that they misunderstand sunk costs.

If you’ve spent tens of thousands of dollars on due diligence and months of your company’s time, and the deal doesn’t appear attractive - well, due diligence has served its purpose and saved your company millions.

To think otherwise, or that, ‘we’ve gone this far, so let’s keep going’ is a challenge that everyone undertaking due diligence is likely to come up against at some stage.

10. Using information gathered to make an accurate valuation

Even a relatively short period of due diligence on a small company can yield a huge amount of new information, virtually all of which will have some bearing on a valuation of the company.

This could be anything from a previously unrecognized inefficiency at a manufacturing plant to a potentially damaging upcoming litigation case. Due diligence can throw up anything.

The challenge then becomes how to revalue the company on the basis of your findings.

Conclusion

This article presented just a handful of the most common challenges associated with the due diligence process.

There may be more, but most will be variations of the 10 that we have outlined.

Every time one of these challenges arise, never lose track of the ultimate goal of due diligence: to gain a more in-depth understanding of the company which is the subject of the due diligence process.