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.
1. Financial 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 or call us at (844) 878-1800 (toll-free U.S.).
