Due Diligence for Mergers and Acquisitions [Part 1]
Since most mergers and acquisitions are complex and may carry some risk, performing due diligence is a crucial step, which cannot be overlooked or treated mildly. During this rigorous investigation involving in-depth research and fact finding, interested buyers evaluate whether the target company will be a potentially profitable and worthwhile purchase. At the same time, the selling shareholders can assess the buyers’ history as well. Although this can be a lengthy process, due diligence becomes much more manageable with a thorough checklist, though the diligence stage should not be mistaken simply as a “check the box” process.
“Due diligence lets potential buyers propose a fair purchase price.”
During due diligence, both parties can expect to uncover underlying or lingering legal, tax and corporate issues that a cursory investigation would not otherwise reveal. Due diligence provides a more complete picture of the business, allowing potential buyers to accurately propose what they deem as a fair purchase price. In addition, depending on what the due diligence unearths, it can provide an opportunity for the buyer to incorporate specific obligations in the purchase agreement that the seller must complete before the sale will be finalized. This can include clearing liens, repaying certain debts, obtaining third party consents or other proposed solutions.
While due diligence is often facilitated by the interested buyer, selling shareholders should also perform their own diligence. This is especially true when the transaction is a strategic merger that includes a significant amount of the acquirer’s stock, or when stock options constitute a major part of the transaction.
We’ve put together a checklist of the most essential items to research during any merger or acquisition. Given the number of factors involved in a transaction, we’re including part one here, and will follow up with part two in a second blog post:
This is usually the driving force behind most transactions: The potential buyer is seeking a way to boost profits. Both the buyer and the seller should learn as much as possible about each other’s financial histories and any related financial metrics.
- Review the other company’s annual and quarterly financial statements, general ledger and budgets for at least the past three years and gather statements audited by an outside accounting firm
- Review projected profits and losses to determine the likelihood of the projections coming to fruition
- Calculate the amount of normalized working capital needed to keep the business operating and ensure both parties are consistent in defining “working capital”
- Investigate all liens, liabilities and outstanding or guaranteed debt, including the terms, interest rates and repayment conditions
- Review a schedule of the accounts receivable and accounts payable
Use this data to determine whether the profit margins are increasing or decreasing. If profit margins are increasing, it will make the transactions more enticing; however, if margins are decreasing, it will be more challenging for the selling shareholders pitching the sale.