There are plenty of reasons why a serious buyer should conduct due diligence before committing themselves to a merger and acquisition.
The top reason, however, is because due diligence lowers the risk of the deal for the buyer.
There isn’t one way to go about the process, but the steps outlined in this blog have guided many successfully over the years. By following these steps, you will position yourself well during negotiations.
Here’s everything you need to know about due diligence from the buyer’s perspective.
Due diligence overview
What exactly is due diligence, you might be asking.
Here is a handy definition from the Corporate Finance Institute:
“Due diligence is a process of verification, investigation, or audit of a potential deal or investment opportunity to confirm all relevant facts and financial information and to verify anything else that was brought up during an M&A deal or investment process. Due diligence is completed before a deal closes to provide the buyer with an assurance of what they’re getting.”
So, due diligence does one of several things:
- verifies the seller’s information (contracts, finances, intellectual property, customers),
- investigates claims by the seller and,
- allows the buyer to see whether this deal complements their investment efforts.
Why is buyer due diligence important?
Due diligence is an essential audit that must be done in order to fully assess the situation and discover any risks that may alter the way the deal must be structured so that the buyer can make an informed quality decision.
Every business has its own obligations. It’s during this critical research stage that a buyer can properly see these obligations and their extent. We are referring here to the seller’s:
- Compensation agreements
- Pending (and potential) lawsuits
- Employee contracts
- Distribution agreements
- Established customer agreements
The information from the due diligence process will give the buyer the needed room to adjust their expectations, furnish them with data to be leveraged during negotiations, as well as identifying risks, and figuring out what risk management measures to adopt.
Essentially, buyer due diligence is a way of protecting oneself.
Because it is a process that requires a lot of back and forth between the parties, it can also act as a good way to cement the working relationship.
When is due diligence carried out?
At what stage does the buyer commence the due diligence process?
Following the signing of the Letter of Intent (LOI), the buyer can begin assembling a team to carry out the review of the company they intend to merge with or purchase.
It is worth noting here that due diligence can take anywhere from several weeks to several months to complete depending on the complexity of the business being audited and its size.
Why is this good to know?
Because there are costs involved with the investigation.
And who pays for these expenses?
Each side – seller and buyer – is responsible for their own team’s fees.
Now that we understand exactly what buyer due diligence is, why it is important, and when to begin the operation, we can look at what steps to take next.
Buyer due diligence: Step-by-step process
Step #1: Assemble due diligence taskforce
It is the responsibility of this team to conduct the investigation, compile the information into a report, and provide feedback to the buyer on the best way forward.
Professionals who should feature in this team include legal and financial M&A experts, accountants, personal consultants, and investors.
They will know what to look for and where to look to get the answers needed by the buyer.
Step #2 Request for documentation from the seller
In this step, the due diligence taskforce creates a checklist of documents they require from the seller.
They must also specify a date on which they would like to have received all the documentation so that the undertaking can proceed in a timely manner.
Will a seller hand over sensitive company information you’re asking?
Yes, because a confidentiality agreement will have been signed prior to the seller handing over their company documents.
What sort of documents will the taskforce require? There is no standard as these will be determined by the type of business being audited. However, the most common documents requested are:
The purpose of this step is for the buyer to obtain a solid understanding of the company in question’s financial health, legal standing, operational assets, and strategic positioning in the market.
Step #3 Document review and requests for additional information
The due diligence taskforce carefully reviews the documents received from the seller. They may also request more information from the seller at this stage.
There are elements the team is looking for – red flags – if you will.
Any information that can delay the deal, puts the buyer in financial distress or affects the timeline can all be flagged by the taskforce.
Depending on the severity of these red flags, the buyer might choose to not continue with the deal or may opt to negotiate and restructure parts of the business acquisition.
Step #4 Taskforce writes a purchase agreement
After reviewing the information provided by the seller, the team in charge of due diligence will then write a report with their findings and draft a purchase agreement that outlines the final deal terms based on the outcome(s) from diligence.
This purchase agreement reflects the problematic areas discovered and risks. It also highlights the positive aspects of the seller’s enterprise in order to give a fair and balanced assessment.
Once this purchase agreement is completed it is sent to the seller for approval or perhaps negotiation – depending on whether or not the deal needs to change based on diligence findings.
And there you have it. The most common steps taken by a buyer conducting due diligence.
Deals that have been carefully audited and reviewed stand a higher chance of succeeding. A diligent buyer will take the necessary time to evaluate any investments before committing themselves.
Mitigate risk by taking time to understand the deal, its risks, and how this M&A will fit into your portfolio.
If you would like to discuss buyer due diligence with an M&A business broker or schedule an advisory services consultation don’t hesitate to contact us.
Disclaimer: Any information provided in this blog is not intended to replace legal, financial, or taxation advice given by qualified professionals.