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A critical process prior to any merger or acquisition, due diligence is much more than an exercise in verifying data. It must scrutinize the strategic rationale and probe for strengths and weaknesses and expose unreliable assumptions and other flaws in logic for the business case.
Mergers and Acquisitions
A merger is…
... the joining together of two willing partners.
An acquisition is…
... the take-over of one organization by another, whether hostile or agreed.
In practice, one of the two organizations is usually the stronger and tends to impose its power structure and systems on the other.
What Is Due Diligence?
Due diligence is used to investigate and evaluate a business opportunity such as a merger or acquisition. The term due diligence describes a general duty to exercise care in any transaction. As such, it spans investigation into all relevant aspects of the past, present, and predictable future of the business of a target company.
This is the time when you will have access to all of the target company's books, records and files. You will have a pre-determined due diligence period in which to investigate the information that you have been given so far, to ensure that it is true and accurate. The due diligence phase is also the time when many prospective business buyers make the most expensive mistake of their lives!
Why Is Due Diligence Conducted?
There are many reasons for conducting due diligence, including:
- Confirmation that the business is what it appears to be
- Identify potential ‘deal killer’ defects in the target and avoid a bad business transaction
- Gain information that will be useful for valuing assets, defining representations and warranties, and/or negotiating price concessions
- Verification that the transaction complies with investment or acquisition criteria
Every business has secrets. Every seller knows certain things that they definitely don't want you to discover. The question is: Are you going to learn their secrets before or after you buy? Due diligence is the way to discover everything before you buy. Once you close the deal it's too late! There's little or nothing that can be done about it. The consequences can be significant.
When Is Due Diligence Conducted?
Initial data collection and evaluation commences when a business opportunity first arises and continues throughout the talks. Thorough, detailed due diligence is typically conducted after the parties involved in a proposed transaction have agreed in principle that a deal should be pursued and after a preliminary understanding has been reached, but prior to the signing of a binding contract.
How Is Due Diligence Conducted?
The parties conducting due diligence generally create a checklist of required information. Management of the target company prepares some of the information. Financial statements, business plans and other documents are reviewed. In addition, interviews and site visits are conducted. Finally, thorough research is conducted with external sources – including customers, suppliers, industry experts, trade organizations, market research firms, and others.
Preparation is the key! In order to conduct a thorough investigation you must have everything in order before the due diligence process begins. In fact, you must start your due diligence preparation and information gathering the moment you decide that you are interested in a particular business.
You must arm yourself with:
- A detailed listing of the exact due diligence steps to follow
- A checklist of everything to complete in each due diligence area
- Specific due diligence tasks that need to be completed
- All of the materials you need from the seller before you start
How Long Does It Take?
Allow yourself the time you need to do it right. Sellers will often push for as short a due diligence period as possible. Unexpected problems are the last thing they want to deal with at this stage. They can just ‘taste’ their money at this point. Imagine what secrets they must have if they want to limit your due diligence time. If the business is as wonderful as they say it is, wouldn't it make sense to let you take your time so that you are certain to buy?
If you feel pressurized into an unrealistic deadline, walk away from the deal. And, if at the end of this period you still need time, then get it. You cannot move ahead with a deal simply because you ran out of time for due diligence.
Key Lessons
- Resist ‘deal fever’ and ensure the case for acquiring is robust. Scrutinize the strategic rationale underpinning the deal.
- Do not treat due diligence as an exercise in verifying the target’s financial statements – rather, it should be a fair analysis of the deal’s strategic logic and your ability to realize value from it. Test every assumption and question every belief.
- Be prepared to walk away from the deal, even in the very late stages of negotiations if you continue to have niggling doubts about it.
- Guard against overestimating the synergies available from the acquisition – a common mistake. Instead look at the deal coldly, without bias or overconfidence.
Source: http://www.astutediligence.com/Diligence_Basics.htm, (December 2004)
