Due diligence is what underpins all successful M&A transactions.
There is simply no substitute for understanding a firm and its operations in minute detail before acquiring it. DealRoom works with hundreds of companies that turn to us for our virtual data room services.
This guide draws from many of the valuable insights provided by those companies, and should provide a solid primer for anybody looking at performing due diligence for the first time.
If you’d like to know more about how DealRoom can transform your company’s due diligence process, visit our due diligence solution page.
Due diligence is a solid review or audit of a company, usually undertaken before a merger or acquisition. The aim of due diligence in business is to ensure that any decision taken regarding the company in question is an informed one, maximizing your chances of adding value in an M&A transaction.
“I like not fair terms and a villain’s mind.”
This line from Shakespeare’s Merchant of Venice shows that some form of due diligence existed all the way back to 1605.
In fact, the first known usage of the term ‘due diligence’ came shortly before Shakespeare’s play in 1598. But due diligence may be as old as transactions themselves - with the transaction itself creating a need to know more about the other side.
It wasn’t until the 20th century that due diligence took on the more structured form that we know today. The first time that due diligence is mentioned in SEC documents was 1933, but it is fair to assume that the arrival of more sophisticated management accounting methods in the second decade of the twentieth century, saw the first tentative steps in modern due diligence.
In mergers and acquisitions, we typically think of four major types of due diligence:
A merger or acquisition is the biggest corporate transaction that any business will undertake.
Due diligence enables companies to undertake these transactions from an informed standpoint.
It can add significant value for the buyer by showing where the target company’s weaknesses (or red flags) are as well as identifying some opportunities within the target company that it previously wasn’t aware that existed.
Gaining an in-depth understanding of a company can be a highly specialized process beyond most people without experience in the field.
There tend to be a myriad of challenges, but the following are usually among the most commonly encountered:
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:
You can find the detailed due diligence checklist below.
Our library of pre-built ready to use playbooks enables teams to thoroughly and effectively collect necessary diligence information.
Due diligence in M&A is a lengthy and intimidating process that involves multiple parties and phases. Listed are general due diligence process steps.
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.
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.
Some of the Items inspected here include:
The detailed financial due diligence checklist could be found here.
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.
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.
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.
Risk management is looking at the target company holistically and forecasting risks that may be associated with the transaction.
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.
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:
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:
Conducting proper due diligence is an important, yet tedious process. Here are a few helpful tips:
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.
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.