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Due Diligence In Mergers and Acquisitions

Updated: Apr 23, 2023

Following liberalisation, the Indian economy started welcoming international clients and markets. Mergers and acquisitions have since spread throughout the country and are one of the quickest methods for businesses to get a competitive advantage.

Mergers are the amalgamation or simply the union of two companies. For example, Company ‘A’ merges with Company ‘B’ and cease to have ownership while the latter dominant company attains greater value. It may absorb or merge with another company.

Acquisitions happen when the receiving company purchases the interests of acquired shareholders and ultimately ceases to have an interest in them.

M&A deals typically require buyers to be certain of numerous details before finalising the deal. It involves him being aware of what he is purchasing, the commitments he is bound by, the nature and scope of the seller's contingent liabilities, contracts with potential difficulties, litigation and IP issues etc. Raising issues in M&A deals have highlighted the need for consumers to be more cautious about potential risks in financial statements, data fraud, cybersecurity issues, and potential employment law and liability for sexual harassment.

What is Due diligence?

Due diligence means verifying all relevant facts and financial information as well as any other information that is being dealt with during an M&A deal or investment process. It involves investigating or auditing a potential acquisition or investment opportunity before the contract is formally signed and thus, due diligence gets completed to give the buyer a guarantee of what they're obtaining. Simply putting it together, enables the buyer to get a full image of the company they are purchasing and make an informed decision with certainty.

It is important to note that the process of due diligence begins as soon as the Letter of Intent is signed due to the following reasons:

  • To confirm adherence to pertinent legislation and disclose any regulatory restrictions on the proposed transaction.

  • To calculate the value of various tangible and intangible assets, including the physical plant and equipment.

  • To choose an appropriate purchasing price and a payment plan.

  • To confirm information that might be crucial for the acquisition agreement's formulation.

  • To identify obligations or dangers that might be deal-breakers.

  • To investigate any possible antitrust concerns that would prevent the proposed M&A

  • To evaluate the transaction's financial and legal risks

Common steps involved in the due diligence process

The due diligence process is complicated and lengthy. The time depends on the nature of M&A deals. Let’s look at the simple procedure involved.

  1. Putting together a team that will be in charge of carrying out the due diligence is the first step.

  2. The purchaser would require a team of legal and financial experts with knowledge of M&A to ensure that the process is carried out correctly. The Investors, accountants, attorneys, personal consultants, and, depending on the sector your company operates in, other service providers make up a due diligence team.

  3. Next, due diligence teams are required to collect crucial documents, wherein they would require to create a thorough checklist of these documents and develop their due dates. Such documents and information can be asked from the target company once parties to a confidentiality agreement have exchanged signatures.

  4. Depending on the type and nature of the firm, the appropriate documents needed for due diligence may vary. Documents like - the history of litigation, stakeholders’ data, IP contracts, and corporate records are always sought. The purchaser may seek information on laws, insurance, leases, and other finances.

  5. The purchaser and target business can set up meetings to go over/ establish or review the M&A procedure and documentation needs. This will ensure compatibility between the parties and the purchaser can be certain of his investment.

  6. The buyer must be fully aware of the other party’s financial situation, operational resources, legal issues, and strategic positioning. A flaw with any of the facts given could prevent the M&A deal from coming to reality.

  7. The important step now is to review all of the data obtained by the purchaser and the target business is accountable for the errors or doubts in information and documentation the buyer poses. The purchaser has the right to ask for more information if the information provided by the target business does not satisfy their requirements.

  8. The due diligence team will examine the documents and mark "red flags" where potential issues or risks arise.

  9. The team will now evaluate if some modifications must be done or if the deal must be altogether abandoned. The due diligence team may address any queries or issues with the target business promptly to speed up the process.

  10. Ultimately a purchase agreement is drawn and submitted for approval to the target company when the buyer is pleased with the information provided and decides to move forward with the deal.

  11. This report will contain an overview of any issues that were detected during the due diligence procedure, as well as any areas that were judged to be satisfactory. The buyer will wrap up the report with a final evaluation of the transaction. The buyer will then view the purchase as a wise investment, and the deal will proceed as expected.

  12. Occasionally, the buyer may ask that the agreement be changed in light of what they discovered while conducting their due diligence. The buyer may get out of the contract if the issues prove to be too difficult to fix.

Types of Due Diligence

Several kinds of due diligence are required for potential business deals in M&A. Read more to find out what these are:

  1. Financial Due Diligence - You must carefully examine the targeted company's finances, including revenue analysis, a study of business operations, a gross profit margin analysis, a breakdown of working capital and debt, a financial statements examination, etc. During this stage, it's critical to pinpoint important qualities, do research, and highlight potential deal-breakers.

  2. Legal Due Diligence - Assessing the target company's legal characteristics and locating any legal problems is an important type of due diligence which highlights the legal considerations and aids in minimising potential conflict-prone areas.

  3. Operational Due Diligence - Identifying potential risks and taking steps to reduce them is important. Human Resources, Information Technology, manufacturing and production management, market review, warehouse management, and supply chain management can all be used to prevent operational failures, which can be detrimental to the entire business.

  4. Due diligence in accounting - Making sure that the financial information that has been given is accurate and truthful is a major concern here and hence most reliance is placed on accounting due diligence.

  5. Commercial Due Diligence - Due diligence in this case aims to determine whether the company's revenue and cash flow can be sustained over the long term as an investment and whether it has the potential to expand.

  6. Due Diligence for the Environment - The due diligence team should concentrate on disclosing any environmental hazards that might be related to purchasing business now or in the future.

The consumer can prepare themselves according to the target firm's view by conducting due diligence, which enables them to obtain extensive details about the business subject to merger or acquisition. The purchaser can protect themselves from such dangers by conducting due diligence. Additionally, it aids in the formulation of practical solutions and excellent planning for a seamless integration process. A healthy working connection between both parties is facilitated by consistent hard work. Companies may attempt to neutralize the risks involved and achieve success in efficient mergers and acquisitions with the strict firm commitment already in place.

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