In any merger & acquisition transaction, the prospective buyer is potentially exposing themselves to significant risks. If the target fails to perform as expected or yields unanticipated liabilities, the acquisition can do enormous financial and reputational damage. As a result, prior to completing any acquisition a prudent acquirer will undertake a detailed and systematic review of all aspects of the target company’s business and industry. This process is commonly referred to as due diligence (DD).
The goal of DD is to ensure the acquirer is as fully informed as possible about the possible risks of an acquisition prior to completing the transaction.
It is important to recognise that while it is the acquirer who undertakes DD to satisfy their own requirements and expectations, a seller has a clear vested interest in ensuring that they are fully prepared for and cooperative with the process.
That is because where DD presents unexpected issues or itself becomes a challenging process to adequately complete, depending on the magnitude of the risks and challenges involved, a buyer may seek to:
In this blog post we provide an overview how a standard DD process unfolds in an M&A transaction. Our goal is to provide a prospective seller with an insight into what they are likely to experience as they progress with a transaction.
Due diligence is typically undertaken by a prospective buyer once a term sheet has been signed and the seller has committed to engaging with the buyer on an exclusive basis. Given the time and potential expense of DD, a buyer will only commence the process once these elements are in place.
Much of the in-depth due diligence work is performed by external experts brought in by the acquirer. These experts typically include accountants, investment bankers and lawyers as well as other specialists such as engineers based on the nature of the business being reviewed.
Depending on the size of the acquirer, some of these tasks might be performed in-house. For example, a large corporate acquirer or private equity firm may have dedicated internal resources who can perform a portion of the required due diligence tasks.
A successful DD process will be carefully planned by the buyer with clear information needs and timeframes. In addition, these requirements and expectations must be conveyed to the seller along with establishing clear communication channels between the parties, including all advisors.
The buyer’s specific information requirements will be distilled into detailed questionnaires (due diligence questionnaire or DDQ) that itemises all of the documents and information that the prospective buyer needs from the target in order to conduct its detailed analysis.
Prior to the commencement of due diligence, it is also important to set clear protocols to protect the confidentiality interests of the seller. For example, the seller may not want its employees to know that a transaction is on foot. These sensitivities need to be respected and managed.
Due diligence is generally not a quick affair. It can take weeks and possibly even months to complete with timeframes influenced by factors including the size and complexity of the target and transaction, the level of comfort the buyer needs and whether the seller is prepared and cooperative.
A comprehensive due diligence program will review and analyse several key aspects of the business. Typically, these areas are:
Commercial due diligence (CDD) seeks to understand the seller’s commercial prospects based on a detailed analysis of the company’s business and the broader industry(s) in which it operates. This review provides the purchaser with an insight into the credibility of the company’s forecasts.
While the specifics of CDD will always be tailored to the unique circumstances of the seller’s business, common aspects of CDD include:
The scope and emphasis of legal due diligence (LDD) will very much depend on the specifics of the seller’s business and the areas of legal risk that have been identified by the buyer and their legal advisors.
For example, if a seller operated in, say, the aged care sector, a key area of LDD would be around the company’s current and historical compliance with the onerous regulatory obligations of that specific industry.
Nevertheless, there are common areas of LDD that apply to most companies. These include a review of the following:
The role of financial due diligence (FDD) is to provide an acquirer with a level of comfort around the integrity of the financial information provided by the seller, particularly in relation to the seller’s financial performance and position.
Those charged with undertaking FDD will engage with the seller to better understand the historical and forecast financial performance of the business and the accounting and financial systems that the business has in place.
At the beginning of the due diligence process, the FDD team will formally seek a range of information and material from the seller including annual reports, audit files (if available), management accounts, tax returns, business plans and forecasts, board papers and so on.
Key areas of the FDD report will include:
As part of the due diligence process, an acquirer will conduct a review of the company’s management team to determine its strengths and weaknesses, assess whether there are any gaps in skills and experience and also consider the extent of key-person risk.
Another more intangible consideration will be trying to assess the prevailing corporate culture within the seller’s business and whether it will be relatively easy to integrate management and staff into the new business and what the challenges of doing so might be.
Beyond the standard areas of due diligence outlined above, certain transactions may require additional specialist due diligence reports.
For example, a company that operates in mining or chemicals might require an environmental due diligence report or a company that operates in highly technical fields such as IT or biotechnology may require dedicated expert reports into their underlying technology.
Due diligence is a key milestone in the progress of any M&A transaction. While it is the buyer who conducts due diligence, it is in the interests of both parties to work cooperatively to make the due diligence process as transparent and frictionless as possible.
For a seller, being ready for due diligence is a significant undertaking that requires careful and thorough planning and preparation. If you would like to discuss how CFSG can assist you in readying your business for sale, please don’t hesitate to contact us.