Due Dilligence In Mergers And Acquisitions

Due diligence is a phrase that is often used but seldom understood. In essence, as the buyer, it is your responsibility to thoroughly check what you are buying. In this process, you can expect the assistance of the seller and it is only reasonable. But do not assume that the seller is telling you the truth, not hiding anything material and providing you with everything you need for your detailed review, including answering any questions that may arise from your investigation.

Due diligence can take anything from six to twelve weeks, and for major public corporations can be much longer.
Why is due diligence important? The purpose of due diligence is to make sure that the buyer knows exactly what he is buying. The seller knows his business inside out or should do. The buyer has to find out as much as he can in the limited time available to try to identify any unknown risks, as well as to verify what he has already been told about the business. This will enable the buyer to finesse the key terms of the deal or renegotiate if necessary. It will also provide the evidence and context for the representations and warranties in the sale and purchase agreement.

What information is requested? The information request is normally provided by the buyer’s advisors and will ask for all the material information regarding the business, including the memorandum and articles of association, recent audited financial statements and current business plans and forecasts, all taxation returns and information, employment contracts, personnel records, details of employee benefits and pension schemes, materials, sales contracts, supplier contracts and distribution agreements, licensing agreements, intellectual property matters, and all real estate agreements, deeds, details of any outstanding legal issues.

This information request is normally accompanied by a list of questions covering financials, legals, customers, suppliers, and distributors and employees and management. There is no standard document as every business is unique, and the preliminary inquiries should be prepared focusing on the appropriate areas of focus for each deal situation. A real estate company is likely to be very different to a software company. Each advisor conducting due diligence, accountants and lawyers primarily, but also potentially including specialists looking at environmental issues, customers and suppliers, the market and technology will have their own extensive information request lists.

In the 1980s and even in many following years, a data room was a physical space. It was occasionally at the office of the business concerned, but more likely at that of their lawyers or accountants. This meant that often hundreds of files had to be compiled and transported to the room, and then the other side would physically turn up and sift through the documents looking for the hidden skeletons.

The advent of virtual data rooms, which are now common practice, means that data can be assembled much faster and shared securely on a global basis with the minimum of inconvenience to both sides. Virtual data rooms are also a boon to confidentiality as large numbers of suits are not invading the offices of the target company for weeks on end, creating rumour and disquiet among the employees.

If you are preparing a process, make sure that your company starts to compile the virtual data room as soon as possible so that this does not become a break on the deal process. If you can consider sharing some information, the less sensitive material before the LOI is signed, to enable your counterparty to make some progress on due diligence before this landmark, this may also enable you to negotiate better terms or remove caveats from the LOI.

An issue to address early on is whose due diligence list should you use? The buyer will find it much easier to manage and assimilate information if it is delivered in accordance to their standard practice. The seller may have already prepared their information according to their advisor’s protocol and be reluctant to reorganize all the information to suit one particular counterparty.

Public companies will also have different requirements to private companies just to add an extra wrinkle to the process. Public companies are forced to disclose much more information, which is then available for review, but private companies are not subject to these disclosure requirements, so the list is likely to be much shorter for them.

Prior to agreeing LOI, a buyer team should spend at least a day going through all the deal issues with the whole team. Your objective should be to establish levels of materiality and identify the key issues that stand between you and closing the deal. What approach are you going to take? Are you going to push hard or adopt a more wait and see approach? Your negotiating position may evolve as the other side discloses relevant confidential information, and you do not want to trade off your concessions too early. It is important to keep the deal issues list as short as possible.

If necessary. Have a longer list of B points which you want confirmed in due diligence, but that you will not raise as issues in the early discussions. Do not forget that some of the most contentious issues arise around key positions and what will happen to senior personnel after the deal. Get these issues sorted quickly. This will not of course overcome the issues of personality when strong, A-type manager, will attempt to impose their perspective on a deal to satisfy their personal agenda rather than contributing to the deal as a whole. It is better to get the people issues sorted out before you invest heavily in the due diligence process only to find that they are insurmountable.