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The Ultimate Guide to the Due Diligence Process in M&A

The information collected and discovered during due diligence is vital to a deal’s success. The due diligence process is comprehensive and teams need innovative software to productively complete diligence. Here is everything you need to know about due diligence process, what steps to take, and how DealRoom can help.

How to Do Due Diligence

Due diligence is the thorough analysis of a commercial business, done typically by a potential buyer prior to business transactions. Common examples are in preparation for mergers and acquisitions (M&A) or purchasing new facilities. In order to complete investigation, specialized teams collaborate to compile and review data including:

  • Income statements
  • Balance sheets
  • Partnership agreements
  • Existing contracts
  • Profit/loss records
  • Annual reports
  • Tax filings
  • Business and operational practices
Due Diligence Process: What is it

What is the Due Diligence Process?

Due Diligence Process Steps, Policies and Procedures Explanation

Due diligence in M&A is a lengthy and intimidating process that involves multiple parties and phases. Listed are general due diligence process steps.

1. Evaluate Goals of the Project - As with any project, the first step delineating corporate goals. This helps pinpoint resources required, what you need to glean, and ultimately assure alignment with the firm’s overarching strategy. This involves introspective questions revolving around what you need to gain from this investigation.

2. Analyze of Business Financials - This step is an exhaustive audit of financial records. It ensures that documents depicted in the Confidentiality Information Memorandum (CIM) were not fluffed. Additionally, it helps gauge the company’s asset health, asses overall financial performance and stability, and detect any red flags. Items inspected here include:

  • Balance sheets and income statements
  • Inventory schedules
  • Future forecasts and projections
  • Revenue, profit, and growth trends
  • Stock history and options
  • Short and long-term debts
  • Tax forms and documents
  • Valuation multiples and ratios in comparison to competitors and industry benchmarks

3. Thorough Inspection of Documents - This due diligence step begins as a two-way conversation between buyer and seller. The buyer asks for respective documents to audit, conducts interviews or surveys with the seller, and goes on site visits. Responsiveness and organization on the seller’s end are key to expedite this process. Otherwise, it may create an arduous experience for the buyer.

Following, the buyer examines the information collected to ensure proper business practices as well as legal and environmental compliances. This is the major part of due diligence process. Overall, the buyer gains a better understanding of the firm as a whole and can better appraise long term value.

4. Business Plan and Model Analysis - Here, the buyer looks specifically at the target company’s business plans and model. This is to assess whether it is viable and how well the firm’s model would integrate with theirs.

5. Final Offering Formation - After information and documents are gathered and examined, individuals and teams collaborate to share and evaluate their findings. Analysts utilize information collected to perform valuation techniques and methods. This substantiates the final dollar you are willing to offer during negotiation.

6. Risk Management - Risk management is looking at the target company holistically and forecasting risks that may be associated with the transaction.

How Long is Due Diligence Period

While road mapping, it may seem difficult to forecast how much due diligence is enough.  Despite its comprehensive nature, the due diligence process should only last between 30 and 60 days. This is achievable if delegated to an efficient, dynamic team from multiple business functions. Ultimately, you want to close the deal as soon as possible, while also being thorough.

But, in reality, it is impossible to uncover all issues and potential complications during the investigation. Some items will not be uncovered until integration. However, the same idea applies to potential benefits. This reinforces the importance to be energetic and efficient while maintaining quality to meet the due diligence period deadline.

How Many Due Diligence Requirements are There

Cultivating good organization and strategizing is key when trying to navigate due diligence process and meet the necessary requirements. So you can stay systematic, outlined below is a typical due diligence management folder structure for M&A transactions:

  1. Transaction Related Documents
  2. Corporate Documents
  3. Contracts and Agreements
  4. Customers, Sales, and Marketing
  5. Procurement (Suppliers)
  6. Property and Equipment
  7. Environmental
  8. Legal, Litigation, and Regulatory
  9. Intellectual Property
  10. Financial
  11. Tax
  12. HR and Employees
  13. Insurance
  14. Operations
  15. Information Technology
  16. Industry and other

Download Due Diligence Checklist

DealRoom's Due Diligence Reports and Checklists help team efficiently manage due diligence from the start. Diligence incorporates many moving parts and it is critical to a deal's success. This checklist enables teams to thoroughly and effectively collect necessary diligence information. Download Checklist Now!

Download Due Diligence Checklist Template

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How to Do Due Diligence on a Private Company

No two M&A deals are the same. Each incorporates its own character of size, business owner and leadership personalities, culture, and industry to create a unique transaction. One factor that makes transactions more complex and due diligence process more complicated is when a company is privately held.

Unlike publicly traded companies, private companies are not auctioned and traded conventionally on the stock market. Investors cannot easily buy shares unless they are founders, employed there, or have invested via venture capital or private equity firms. Aside from it being more difficult to invest in private companies, they are not obligated to publicly disclose as much information. Compared to private companies, public companies are also held to stricter business and accounting practice standards.

While buying out privately owned companies and startups may have a high payoff and rewards, they come with distinct complexities. These may affect or hinder the M&A process. To save some headaches down the line, detailed here are some best practices for the private equity due diligence process:

  • Understand Your Financial Situation - Before even researching companies or drafting out an LOI, you need to look at your own books. Do you have enough resources to complete the transaction and bounce back if it does not work out? If not, maybe consider a smaller scale investment or wait a little while.
  • Accounting Procedures and Financial Statements - Publicly held companies must abide by GAAP and IFRS and are audited regularly to ensure compliance. Regulations on privately held companies are not as strict. This allows them to use different accounting procedures or even practices off the beaten path. Rather than traditional accrual accounting, it may not be unusual to see cash-basis or something else more arbitrary.
  • Size - Private companies are almost always smaller than public. This doesn’t only mean fewer employees and less office space, but also likely smaller revenues.
  • Human Resources Practices - Smaller, younger businesses may not have standardized HR processes. Here, you want to check out items such as questionable terminations, harassment charges, hiring practices, and if/what workplace policies exist.
  • Legal - The last thing you want from any investment is to soon find that it is riddled with legal issues. Some details to consider here are tax compliance, any past or outstanding lawsuits, and overall obedience to applicable jurisdictions.
  • Valuation - Valuation methodologies are the same between private and public companies. However, you have to adjust for lack of liquidity and publicly available market caps.
  • Management and Leadership - The company you are considering buying could have been the brainchild of siblings or friends. Meaning, they could be a little protective. You will want to meet and get to know them to determine if there is any hostility associated with the transaction. By and large poor, disgruntled management will trickle down the m&a buy side due diligence process and negatively impact the business.
  • The Business - Overall, do you believe in the company, their strategy, and mission? Is this something you see as truly being successful?

Useful Tips to Conduct Due Diligence Process the Right Way

Conducting proper due diligence is an important, yet tedious process. Here are a few helpful tips:

  1. Use a Diligence Management Software - Diligence management software combines the features of a traditional virtual data room with project management capabilities. This allows users to not only securely store data, but effectively manage and share files as well.
  2. Start Early - The diligence process can be extremely time-consuming. It’s best to get started early in an organized manner. When teams utilize a tool like DealRoom, they can start the process within minutes.
  3. Utilize Checklists - When teams use a diligence management software, they can easily create organized checklists. For example, rooms can be broken down into different stages of diligence. Users can efficiently check items off as they are completed.
  4. Address Potential Risks Throughout the Process - If potential bottlenecks and risks arise during diligence, teams should address them promptly.
  5. Employ Experts - Hiring M&A professionals such as investment banks and consultants make the due diligence process more efficient. Deal teams have experience with conducting diligence and know the necessary steps to take.
Due Diligence Phase of M&A Transaction

Productive and Fast Due Diligence Process with DealRoom

Traditionally, due diligence process is completed using a virtual data room, Excel trackers, and one-off emails. Unfortunately, this leaves room for inefficiencies such as version control worries, miscommunication, duplicate work, and information silos.

With DealRoom, all diligence can be managed within the platform. Teams no longer have to switch between multiple platforms and this allows diligence to be completed up to 40% faster. They can effortlessly share information and collaborate internally, as well as externally with clients.

  1. First, structure your due diligence checklist into the proper format. This includes the following columns: title, description, category, priority, status, labels, start date, and due date. If you need help formatting your checklist, our customer success team can assist you or send you a premade template.
  2. Next, import the checklist into the room.
  3. Once the checklist is imported, assign key roles such as assignee, reviewer, and follower for each diligence request. Users can also set due dates, priorities, and labels. This allows to make the due diligence process transparent and visual for everyone in a team.
  4. To answer a diligence request, simply drag and drop the correlating documents and files into the request. Users can then leave comments and change the status of each request.
  5. To see all your diligence requests, head over to the “assigned to me” section. This is located in the top left-hand corner of the room. From this viewpoint, users can filter through their own requests by priority, status, creator, and more.

Final Thoughts

The due diligence process is never easy, but that doesn’t mean it has to be inefficient and disorganized. With the proper software and workflows in place, diligence can be straightforward and productive. After all, the information that is discovered during diligence is critical to a deal’s success. Due Diligence Software like DealRoom, equips teams with the proper tools to be thorough, yet efficient, and to close deals faster.

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