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How to Conduct Due Diligence When Buying a Business: Advice from M&A Experts

A thorough investigation into, and understanding of, a company during due diligence (learn about what due diligence means here) is essential to a deal’s success - whether you are buying a small business or a larger corporation. However, it is no secret that it can be hard to keep your head above water during diligence. 

The pressure and sheer amount of information that must be gathered and analyzed is enough to make even the best practitioners falter. Additionally, poor work and wasted time during diligence can result in financial loss, when the entire purpose behind acquiring a company is to gain capital. 

With this in mind, DealRoom has worked with expert M&A practitioners  to outline a smarter approach to this chaotic period of investigation and inquiry. We begin with an overview of how to work through the due diligence process. (More information from someone who has gone through an entire M&A process here).

A Step by Step Guide

  1. Evaluate your strategy and rationale behind the deal
  2. Better understand the deal by hosting an Agile-inspired kick-off meeting
  3. Set up your DealRoom
  4. Consult a due diligence checklist
  5. Begin your deep dive into financial statements and documents
  6. Gain a deeper insight into the business via surveys and interviews
  7. Examine and analyze the target’s business model
  8. Put together an offer

1. Evaluate your strategy and rationale behind the deal: 

Pinpointing the overarching goal of the acquisition is the initial step. As we believe in a more Agile-inspired M&A process could link to some Agile pieces), it is important for the overarching goal to be thoroughly understood as this will be the guiding light for teams through diligence.

2. Better understand the deal by hosting an Agile-inspired kick-off meeting: 

The buy-side should take the initiative to set up and facilitate a kick-off meeting. This meeting will increase the rapport between you, the acquirer, and the target company, which can help move the deal process at a faster rate. Similarly, the kick-off meeting is a perfect time to establish clear roles and lines of communication.

Due diligence tools can also be selected at this time, and while VDRs are the new normal in M&A, we recommend selecting a VDR with a project management platform so you are not only storing and sharing documents safely, but also improving communication, efficiency, and transparency. 

3. Set up your DealRoom: 

With the above in mind, DealRoom’s smarter system has been proven to reduce workload during due diligence, as well as limiting the potential for human error; however, whatever tool you ultimately select, now is the time to set it up and send out access invitations to key stakeholders.

For more information about VDRs and Deal Rooms for M&A read Virtual Data Room for Agile M&A

4. Consult a due diligence checklist:

A due diligence checklist is another tool to work through the due diligence process more efficiently. Since a large amount of information must be collected, including financial information, company descriptions, customer lists, intellectual property, and employee profiles, a due diligence checklist can ensure nothing is missed.

DealRoom has a comprehensive checklist that can be accessed here - Due Diligence Checklist, while simultaneously storing all of the collected information in its central hub. 

5. Begin your deep dive into financial statements and documents: 

Financial inquiry typically begins the long list of due diligence questions and requests from the buy-side. Most acquirers will ask for information from the last three to five years. Requested documents include tax returns, accounts payable, accounts receivable, balance sheets, income statements, and credit reports.

6. Gain a deeper insight into the business via surveys and interviews: 

Throughout diligence, you will want to keep an eye towards integration. If possible, having a change management expert on your team is ideal. As you collect information on the target company, interviews and surveys can help paint a more well-rounded picture of the company by providing valuable information related to workflow, company morale, management styles, and potential problems.

For more on change management and planning for integration check out Best Practices in Change Management. 

7. Examine and analyze the target’s business model: 

It is essential for the buyer to closely analyze the target’s business model in order to assess if the acquisition is truly an appropriate fit. Examine the products/services, the customers, the competitors, the projected financials and how these specific aspects of the business match your business strategies and goals. 

8. Put together an offer: 

At this point, all members of the diligence team should come together to share their findings and provide their recommendations. Analysts (often M&A investment bankers) will put together different models and help you determine an appropriate price. 

due diligence phase

How DealRoom Can Be Leveraged To Increase Efficiency During Due Diligence Investigations

1. Reduce distractions: 

Distractions during diligence can have major consequences, yet distractions are common given the amount of work often facing already overworked management teams.

DealRoom’s centralized location helps to eliminate many distractions as stakeholders do not have to go back and forth between emails and other documents such as spreadsheets. More specifically, the messaging system, project management templates, and labeling and filter features allow users to work in a methodical and organized fashion, focusing on a specific document or request. 

2. Increase transparency:

Similarly, increased transparency is another way DealRoom reduces distractions and closes deals faster. In fact, DealRoom allows for a bird’s eye view of the project, which results in team members taking on more proactive roles. This oversight also allows users to track what other users are viewing and spending their time on.

Not only does this increase communication, but it also allows for engagement levels from both the buy-side and the sell-side to be analyzed and potential problems and roadblocks to be easily identified. 

3. Break teams out of silos to improve communication:

Teams working in silos has long been a complaint of M&A practitioners. DealRoom’s smarter system works to break teams out of silos, partially due to the oversight previously mentioned.

Another way DealRoom improves communication is by providing a tagging feature. This feature allows for items to be tagged for later use. Now diligence teams can begin planning for integration and pinpointing information that the integration team will need to use in the future. Truly the entire platform is based around increasing communication and the flow of information between stakeholders. 

4. Avoid surprise costs historically related to diligence:

At this point, we would be remiss not to discuss price. DealRoom uses a flat-rate fee structure rather than the archaic per page pricing model. Now M&A practitioners can plan for due diligence expenses and not have to sacrifice valuable data because they are worried about increased cost.

The flat-rate price not only includes unlimited data, but also unlimited users, making it an appropriate choice for deals of all sizes. For more information on our software be sure to check out DealRoom’s platform.

due diligence when buying a business

Common Mistakes to Avoid When Conducting Due Diligence on a Business

1. Teams Working in Silos:

All too often, teams are not communicating with one another, which can lead to all of the following ineffective workflows: redundant work, increased wait-time, loss of momentum and lack of meaningful collaboration. Becoming more Agile and utilizing DealRoom can assist your teams in breaking out of their silos and being more collaborative and focused on the overarching goal of the deal. 

2. Letting one task or roadblock slow down the entire process:

This common mistake during due diligence is closely related to our above sentiments on teams working in silos. A traditional waterfall style workflow can have teams unnecessarily waiting around for another team’s task to be done. Again, a more Agile workflow and increased transparency via DealRoom’s platform can remedy this error.

3. Failure to plan for integration:

Many deals fail to reach their potential due to poor integration practices. Integration planning should begin during diligence. In addition, members of the diligence team should then become part of the integration team. Finally, don’t forget to take time to get to know the target company and its employees who are ultimately responsible for making  the target successful. 

4. Assuming the target has gone through the M&A process before:

Some companies may not have gone through the M&A process before; therefore, it is essential to help them understand the process and become meaningful stakeholders in the process.

Again, DealRoom’s platform with its emphasis on increased communication can assist you with this. In addition, the previously mentioned kick-off meeting is a great place to review the M&A process with the target. 

Due Diligence Discoveries that Can Stop a Deal In Its Tracks

1. Questionable financials: 

There are a few financial document red flags that are cause for concern during due diligence.

First, you must be wary of statements that seem too good to be true. While it is not commonplace, companies have been known to take questionable actions related to their finances when trying to present themselves in the best light to buyers. This is more likely to be true for companies in financial trouble, such as close to bankruptcy or foreclosure.

Another potential warning sign is financial documents that are not presented in the same format. Finally, foreign accounts that are opened and do not seem to be related to the business, as well as money being wired to third parties that do not seem to be associated with the business, are causes for concern. 

2. A seller who is stingy with information: 

A general rule of thumb is if the seller does not have anything to hide, he/she will be forthcoming with information and data related to the deal.

When a seller is reluctant to share information, especially information that is considered common practice during diligence, the buyer may understandably become suspicious about the seller’s underlying motives. Similarly, when a seller is slow to respond to diligence requests, it can cause the buyer to lose interest or fear the seller is getting cold feet. 

3. Weak and/or complicated management teams: 

Oftentimes, it is the people who make a business successful. Therefore, if the management teams and structures of the seller are weak, the potential buyer should devote more time to investigating potential pitfalls of the deal.

Additionally, if the management structure and style are overly complicated, it is important to consider if maintaining or replicating the current style is a viable option; will it be possible to maintain or replicate this management style if employees leave after the acquisition?

Consideration should also be given to the impact changing the management style might have on the business.

Final Thoughts: 

While it is not a panacea, the right project management platform (learn more about M&A Project Management Software) can help minimize some of the traditional problems associated with conducting due diligence. Specifically, it can be especially helpful for the buy-side. In addition, taking the time to learn from expert practitioners can also lead to a more positive diligence experience.

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