Top 7 Due Diligence Procedures in Merger and Acquisition

Commercial Due Diligence, Financial Due Diligence, Corporate Due Diligence

A buyer is one responsible for carrying out substantive amount of due diligence in a merger and acquisition transaction (M&A transaction). The buyer will want to ensure that it knows all the points related to the agreement and parties, before committing to the contract. Some of these points might be:

  • Entities etc it is buying
  • Issues related to intellectual property
  • Its assumed obligations
  • Problematic contracts
  • Risks associated with litigation
  • Type and range of the liabilities of the target company
  • And many others.

This fact holds water especially in acquisition of private companies that are not subjected to any kind of scrutiny. This is also true in case where buyer has less ability to collect data from publicly available sources. A point to note is that the target company might implement ‘reverse diligence activities’ if the transaction includes substantial stock to the buyer. And this is where you may need due diligence services to properly investigate the company before buying. This is because it has larger scope.

In this article, you will find a concise of important activities of business due diligence that are associated with a standard M&A transaction(both sides/parties). After reading this post, you will be enlightened with the top 20 Due Diligence Procedures in Merger and Acquisition Transaction. Hence, you will be able to plan better and anticipate the issues beforehand to ensure a completely successful consummate of a sale.

  1. Antitrust and Regulatory Issues
  2. Competitive Landscape
  3. Customers/Sales
  4. Disclosure Schedule
  5. Employee/Management Issues
  6. Environmental Issues
  7. Financial Matters
  8. General Corporate Matters
  9. Governmental Regulations, Filings, and Compliance with Laws
  10. Insurance
  11. Litigation
  12. Marketing Arrangements
  13. Material Contracts
  14. Online Data Room
  15. Production-Related Matters
  16. Property
  17. Related Party Transactions
  18. Strategic Fit with Buyer
  19. Tax Matters
  20. Technology/Intellectual Property

Due Diligence Investigation, Merger Due Diligence, Acquisition Due Diligence

  1. Antitrust and Regulatory Issues: Recent years have seen an increase in scrutiny of acquisitions in this field. Buyers are now looking to undertake the below listed activities for assessing the facets of a potential deal such as regulation and antitrust implications:
  • Assessment of the scope to which an anti-trust issue can extend
  • Conclusive understanding of the effect of consolidation trends in an organization on the speed and probability of regulatory / antitrust approval
  • Confirmation of the company’s involvement in preceding inquiries / investigations
  • If the company belongs to regulated industry then it is important to acquire the approval of acquisition from a regulator. In this case, one must have understanding of the issues that are associated with the approval (in terms of pursuing it and acquiring it)
  • In case the buyer is competing with the targeted company, then it is imperative to comprehend the limitations and work around those on the level or timing of diligence disclosures
  • In case the transaction includes foreign investment issues or nation security concerns, then Exon-Florio issues must be considered
  • Issues must be addressed that might include preparation of a Hart-Scott-Rodino filing (that is if the thresholds are being met)
  • And also giving an effective response to “Second Request” from the Federal Trade Commission or Department of Justice.
  1. Competitive Landscape: As a buyer, you must understand the competitive environment wherein the prospected business is operating. You can gather the information on the following points:
  • Benefits and liabilities of the products as well as technologies in comparison to that of competitors
  • Existing or new technologies that will obsolete the company’s present technology and processes
  • Main competitors of the company (existing as well as visioned)
  1. Customers/Sales: As a buyer, you must comprehend the clientele of the targeted company. It should include concentration level of major clients and their sales schemes. You may prepare questionnaire, which should include:
  • Are there any issues or risks related to customer concentration?
  • Are there any issues present with the clientele (present or former customers)?
  • How will the acquisition affect the financial incentives (if any) that are offered to staff? Before this, you should find whether the sales team is motivated or compensated in any way?
  • Is the current customer base satisfied with the company? For this, you can gather the client’s calls.
  • Is there an existing client backlog?
  • What are the comprehensive terms and policies of sales? Has the company faced returns / refunds or exchanges that can be termed out-of-the-way.
  • What is standard revenue rate and what are the basic requirements of the working capital?
  • Which customers are rated in the top 10 and what amount of revenue is generated from each client?
  • Will you be able to retain customers after acquisition of the targeted company?
  1. Disclosure Schedule:

Preparation of disclosure is an important part of M&A transaction that should be done by the targeted company. It should address all the standard points of a due diligence process. Further, it should identify the exceptions related to warranties and representations in the M&A agreement. Preparation of disclosure is a time-consuming process as it requires regular revision and update. Hence, its readying should begin at the initial stage of Merger and Acquisition Transaction.

The disclosure schedule should compulsory cover the following topics:

  • Are the patents (issued + pending) listed and briefed?
  • Are there any disclosures in the said schedule that will disallow the buyer to raise legitimate claims in case some warranty or representation turns out to be false.
  • Does the disclosure schedule list every contract in the targeted online data room? Whether or not their review has been done?
  • Does the listing includes outstanding capital stocks and warrants?
  • Dose any odd agreement exist?
  • Is the analysis of litigation’s potential exposure done?
  • Is the schedule completely as per the warranties and representations that have been imbibed in the acquisition agreement?
  • Is there a full-fledged list of material contracts and corrections that also includes dates and counter-parties?
  • Is there any possible issue in the company’s existing contracts that might cause trouble after the merger?
  • Is there any presence of liens on assets? If yes, then what are its removal procedures during the closure?
  • With the change in company’s control, will there be any affect of any important contract?

Due Diligence Procecedures

  1. Employee/Management Issues:

It is important for the buyer to understand the issues pertaining to the management and/or employees of the targeted company. These issues might include:

  • Biographical data and the complete chart of management structure
  • Solved, present and possible labor disputes / stoppage
  • Transactions involving person of interests like key employees, directors, and officers. The transactions may include documents, loan agreements and consultation agreements.
  • Listings of compensation remunerative to person of interests like key employees, directors, and officers. This should be collected for last 3 fiscal years. The listing should be detailed and must include bonuses, salary and non-cash compensation (all listed separately).
  • Data of benefits, pension, retirement schemes, compensation, incentives, sharing of profit concerning the employees.
  • If stocks are issued, then you must obtain the proof of compliance with IRS Section 409A
  • Potential acquisition is possible, so you should get hold of abidance with IRS Section 280G (golden parachute) rules
  • Manuals as well as policies of employment in the targeted company
  • Participation of important employees and officers in various issues or proceedings related to criminal and civil
  • Existing, discontinued or futuristic plans related to vacation, loans, relocation help, tuition fees, compensation, educational help, loan guarantees, fringe advantages and others
  • Suitability of company’s handling of employees as personnel vs independent contractors
  • What are the retention requisites of agreements with important employees and are these suitable to be retained?
  • Related to acquisition, what are the costs of layoffs and their results
  1. Environmental Issues

As a buyer, you should assess the potential environmental issues concerning the targeted company. In addition, you must analyze the scope of said issues that might impact your business. A standard environment review is among the Top 20 Due Diligence Procedures in Merger and Acquisition Transaction; it should include the following:

  • Accepted Superfund exposure
  • Contractual bonds / agreements, Environmental claims, litigation and investigations
  • Environmental authorizations and licenses
  • Files, notice and/or correspondence concerning EPA, or local / state regulatory agencies
  • Harmful items used in company’s work
  • Information about asbestos that is included in the improvements on company’s owned premises
  • Investigation records or data should be acquired from possible sources like neighboring properties or public agency
  • Reports, data and audits related to environment for all the properties (owned or leased)
  • Unforeseen liabilities related to environment or chronic indemnification accountability
  • Whether petroleum products are used elsewhere other than in passenger automobiles?
  1. Financial Matters.

Herein, you should assess and consider the financial metrics including the historical financial statements of the targeted company. Also, you should consider its potential future performance. Various topics that you can cover under financial matters are:

  • What are the effects / results of the financial statement of last three years on its current performance?
  • Is auditing done? If yes, then what was its frequency?
  • Are the current as well as contingent liabilities covered in the financial statements and allied metrics?
  • What is trend of business growth or loss?
  • What are the facet of company’s futuristic projections – believable and reasonable?
  • What does the chart says for projections in a financial year – company’s vs board-approved?
  • Is the standard working capital enough to pursue the business?
  • What is the formula of “working capital”?
  • What are the current commitments of the company regarding its capital?
  • For growth of business, what additional adjustments are needed and what are extra capital expenditures that are required.
  • What are the stipulations of assets and liens thereon?
  • What is the status of indebtedness? Is it outstanding or company guaranteed? Further, are its terms defined, if yes, that are those terms? What is its repayment time?
  • Is there any undesired or suspicious issue related to revenue recognition?
  • What is the status of receivable accounts and related issues?
  • Are the capital budget and operation budget suitable for the company? What are its future plans in terms of its deferring?
  • Are the calculations related to EBITDA been done suitably? This points becomes mandatory if your are buying a debt financing firm.

One can also contact Bill Trueman a highly experienced specialist in risk review and due diligence for Due Diligence Investigation Services. Bill is a member of AIRFA, and director of RiskSkill.