Legal and Financial Due Diligence are Primary Concerns of M&A Dealmakers
ComplianceMarch 29, 2023

Legal and financial due diligence are primary concerns of M&A dealmakers

In closing a merger or acquisition, failure to have all the ducks lined up in a row, every scrap of information on the risks and opportunities the transaction presents, is dangerous. Due to this, dealmakers experience mounting stress as the signing date approaches.

In this compressed M&A due diligence timeframe, the fear that something crucial will fall through the cracks is ever more possible. When a particularly critical element does not receive the attention it requires, the post-transaction value of the combined organizations is at risk. While the overarching objective of due diligence is to lift every stone to see what lurks underneath, some stones can be more significant than others.

In this article you’ll learn the importance of pre-deal due diligence, two critical areas to pay attention to, how to deal with the unknown, and the work that must continue after the deal is closed.

What is the purpose of M&A due diligence?

Due diligence provides a complete picture of what you're getting into before you make a deal, whether you're buying an asset or company to merge with or run independently. It can reveal hidden costs or liabilities and identify potential legal or contractual obstacles to closing the deal.

In addition to helping gain a better understanding of the seller's business, due diligence can also assist in deciding which representations and warranties will appear in the definitive acquisition agreement, as well as which closing conditions and indemnification provisions are necessary.

Prior to closing a deal, you can confirm that the business you intend to acquire is as represented by the seller. If any unusual business problems are identified, those can be addressed prior to closing or specifically addressed in the acquisition agreement.

Due diligence is also conducted by the seller. This helps ensures that any risk or potential problems are identified and addressed before any sale and informs the true real market value of the company. To attract a buyer, pre-sale due diligence should commence long before the sale process.

Beyond borders. From beginning to end.

We’ll help you with all your merger and acquisition needs by providing a knowledgeable Relationship Manager who is accessible around the clock.

We have offices and expertise around the globe. No matter where your business takes you, we’ll make sure your needs are being met, accurately and on time.

Financial and legal due diligence provide a baseline

During due diligence for M&A transactions, both internal and external sources must be thoroughly examined and analyzed. Depending on the industry, the reason for the acquisition, or the size of the deal, the list of due diligence questions can be exhaustive.

Due diligence may involve IT, intellectual property, reputational and regulatory, operational and commercial, real estate, and even ESG.

No matter the type of deal, two areas you must concentrate on are financial and legal due diligence.

1Financial due diligence

The purpose of financial due diligence is to facilitate deal decision-making, negotiation, and post-announcement planning and execution.

Financial due diligence aims to provide a thorough understanding of all the company’s financials, including:

  • Quality of earnings
  • Accounting compliance
  • Cash flows
  • Balance sheets
  • Any significant operating and financial trends
  • Reviewing GAAP (generally accepted accounting principles) and SEC reporting compliance
  • Valuation and financial modeling
  • Operating or SG&A (selling, general, and administrative) expenses review
  • And more

2. Legal due diligence

Among the primary goals of legal due diligence is to reveal hidden legal liabilities, historical and pending, that come with the deal. This may involve the following:

  • Legal history review
  • Bankruptcy searches
  • Past and pending litigation
  • Unpaid judgments and liens
  • Legal entity structure mapping and post-close filing preparation
  • Legal obligation review
  • Debt structure and credit analysis

Dealing with the unknown

Dealmakers often find legal due diligence to be especially challenging. One reason may be the rapidly changing global legal and regulatory landscape, which increases the risk of overlooking new and evolving laws. Another possible reason is hidden liabilities — legal risks that the successor company inherits once the transaction closes.

Any hidden liability, whether unintentional or designed to hide important business information, is a cause for alarm. For one thing, if the target company has acquired numerous businesses through the years, identifying and mitigating these varying organizations’ legal risks can be daunting. In some cases, the legacy liabilities may extend back several decades — as is often the case with environmental exposures. Even the liabilities for a target acquired company that no longer exists can linger on, and in these cases unraveling the trail of ownership and accountability can be problematic. Meticulous legal due diligence can shed light on such exposures early enough to address within the deal framework, before the complications compound.

Dealmakers that fail to appreciate and evaluate these unknown legal threats can end up with a less valuable acquisition. A legacy environmental exposure, for instance, can cause severe post-transaction financial and reputational repercussions undermining the perceived value of the transaction, in addition to affecting the present and future value of the acquirer.

Because of this possibly dire outcome, be sure to seek M&A due diligence services from an organization that provides comprehensive identification and management of legal issues — before, during and after the close of the transaction. As with any deal, it’s better to sit at the negotiating table with all the details in hand.

Pre-acquisition due diligence is only the beginning

Sometimes merging two companies goes smoothly, while at other times the process is bumpy at best. A common challenge for private equity firms and strategic acquirers is post-merger integration. Management must spend time and money to ensure things run smoothly from the start. Employee buy-in is another important factor to consider. Bringing the two cultures together is crucial.

There are countless instances when two companies that appear to be a perfect match on paper fail. Several factors contribute to this, including improperly marrying technology, poor communication, and an inability to plan accordingly. When these issues arise, employees may leave, which often undermines the original rationale for merging. There are, however, steps that companies and owners can take to ensure success. For more information, see Cracking the code to successful post-merger integration.

Learn More

CT provides comprehensive, end-to-end due diligence services that begin in the earliest stages of an M&A transaction and continue on to ensure post-integration success and assured compliance.

Contact your CT representative today.

The CT Corporation staff is comprised of experts offering global, regional, and local expertise on registered agent, incorporation, and legal entity compliance.

Expert Insights
Stay informed
Subscribe to CT Corporation's newsletters for business compliance updates and legislative news.
Back To Top