A well-timed merger or an opportune acquisition can help your business grow, but it can also expose you and your business to risk. Buyers must consider the strengths and weaknesses of their intended partners or acquisition targets before entering into any new transactions.
When entering into any new buy/sell agreement, a robust due diligence process is imperative in order to avoid the risk of costly errors and financial losses. Due diligence means much more than just assessing the reasonableness of the sales price. It involves examining a company’s numbers, comparing the numbers over time, and benchmarking them against competitors. Proper due diligence can help verify the seller’s disclosures, confirm the target’s strategic fit, and ensure compliance with legal and regulatory frameworks.
What are the phases of the due diligence process, and how can they help in the decision-making process?
- Defining Your Objectives
Before the due diligence process begins, it’s important to establish clear objectives. The work done during this phase should include a preliminary assessment of the target’s market position and financial statements, and the expected benefits of the transaction.
The process should also identify the inherent risks of the transaction and document how due diligence efforts will verify, measure and mitigate the buyer’s potential exposure to these risks.
- Conducting Due Diligence
The primary focus during this step is evaluating the potential purchase’s financial statements, tax returns, legal documents and financing structure.
- Look for red flags that may reveal liabilities and off-balance-sheet items. The overall quality of the company’s earnings should be scrutinized.
- Budgets and forecasts should be analyzed, especially if prepared specifically for the M&A transaction.
- Interviews with key personnel will help a prospective buyer fully understand the company’s operations, culture and its practical value.
AI – A Valuable Resource
With its ability to analyze vast quantities of customer data rapidly and proficiently, artificial intelligence (AI) is transforming how companies conduct due diligence. Using AI, the potential buyer can identify critical trends and risks in large data sets, especially those that may be related to regulatory compliance or fraud.
- Structuring the deal
The goal of the due diligence review is to piece together all of the information reviewed into one coherent picture. When the parties meet to craft the provisions of the proposed transaction, the information gathered during due diligence will help them develop their agreement. For example, if excessive customer turnover, shrinking profits or a high balance of bad debts are revealed during the due diligence process, the potential buyer may negotiate for a lower offer price or an earnout provision. Likewise, if cultural problems are discovered, such as disproportionate employee turnover or a lack of strong company core values, the potential buyer may decide to revise some of the terms of the agreement, or even abandon the deal completely.
Hazards of the Due Diligence Process
Typical challenges in executing a successful due diligence process include:
- Asking the wrong questions, or not knowing what to ask
- Poor Timing – presentation or execution of documents may be delayed or unavailable
- Lack of communication between potential buyers and sellers or their representatives
- Cost – due diligence can be expensive, running into months and utilizing extensive specialist hours
We can help
Comprehensive financial due diligence boosts the quality of information available to decision-makers and acts as a foundation for a successful M&A transaction. If you’re thinking about merging with a competitor or buying another company, contact Roth&Co to help you gather the information needed to minimize the risks and maximize the benefits of a transaction that will serve the best interests of all parties involved.
This material has been prepared for informational purposes only, and is not intended to provide or be relied upon for legal or tax advice. If you have any specific legal or tax questions regarding this content or related issues, please consult with your professional legal or tax advisor.
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