Mergers and acquisitions can be complicated, and up to 20 percent of deals are eventually terminated or withdrawn after the due diligence step. Due diligence is your chance to see exactly what you’re getting into, and whether your offer is truly justified.
While the due diligence process is complicated and should be undertaken with the help of a team of professionals, there are a number of steps that can help guide your journey.
Due Diligence Steps to Follow
These are some of the most important steps in the due diligence process:
- Finances. One of the most important steps to take is verifying the financial history of this company. As the buyer, you’ll need to get a detailed account of the seller’s financial statements and metrics, as well as projections into the future. For example, look at the annual, quarterly, and/or monthly financial statements of the business for the past several years. How has it performed financially? What is its current condition? Have these reports been audited? What kind of internal controls are in place to verify financial reporting? Are key metrics like revenue and margins growing or declining?
- Technology and cybersecurity. Next, you’ll need to examine this company’s current technology and cybersecurity. For example, what kind of technology licenses are they operating with? Are they using open source software or components that require open source due diligence? Which software and applications are vital to the success of the business? What cybersecurity measures do they have in place? What kind of IT infrastructure and devices are available to employees? Are there privacy policies in place for customer data, and how is that data being stored?
- Intellectual property. After that, you’ll need to investigate this company’s intellectual property. What kind of patents does this seller have, domestically and abroad? What steps have they taken to protect these patents? Do they have registered and common law trademarks you should know about? Are they using copyrighted products and/or materials?
- Sales and customers. In addition to understanding revenue and profit margins, you’ll need to understand the seller’s sales and customers. Who are the most important customers for this business, and how much revenue are they generating? Are there major risks or issues associated with these customers? Do customers seem happy with their current levels of service? What kind of outstanding warranties are in place?
- Strategic fit. This is a more open-ended question, but you’ll still need to pursue it in the course of your due diligence. What kind of strategic fit is available by merging with or acquiring this business? Do you share the same long-term goals and values? Will you be able to integrate efficiently? Does this business offer complimentary influence or resources that you can harness to advance your own business?
- Material contracts. Also consider the material contracts and commitments held by the seller. For example, does this seller have any reseller and supplier contracts that will be in place for the next few years? What kind of loans and credit agreements are they working with? Do they have standing settlement agreements, acquisition agreements, equipment leases, and other types of paperwork?
- Employees and managers. Next, take a look at the current employees and management system in place at this business. How many employees are there, and what does the management hierarchy look like? Are employees generally happy? Are there any standing workplace issues, like labor disputes or allegations of discrimination or sexual harassment? What are employees being paid? Are all the right documents accounted for?
- Previous litigation. What is the legal past of this seller? Is there any pending, threatened, or previously settled litigation involving the seller? Make sure you review any current, pending, or prior cases that may have an impact on your merger or acquisition.
- Tax issues. Taxes can get complicated quickly. Has this seller incurred any previous income tax liabilities? What kind of federal, state, and local taxes have they paid in the past? Have they been the subject of any federal audits? Are there any tax sharing and/or transfer pricing agreements in place? Are they complying with withholding tax requirements?
- Antitrust and/or regulatory matters. Antitrust and regulatory issues are also complicated to address. You’ll need to know whether this seller has been involved in antitrust or regulatory issues in the past, and if your proposed plan would cause any new issues to arise.
Proceeding With the Deal
If all these steps check out, you’ll likely be in a position to proceed with the deal. But don’t be afraid to put things on hold or even withdraw the deal if there are too many prospective issues to hash out. Otherwise, you can reenter negotiations and find an agreement that works for all parties involved.