Best practices for M&A due diligence

1. Defining the scope

Before the due diligence process begins, it’s important to establish clear objectives. The work during this phase should include a preliminary assessment of the target’s market position and financial statements, as well as the expected benefits of the transaction. You should also identify the inherent risks of the transaction and document how due diligence efforts will verify, measure and mitigate the buyer’s potential exposure to these risks.

2. Conducting due diligence

The primary focus during this step is evaluating the target company’s financial statements, tax returns, legal documents and financing structure. Additionally, contingent liabilities, off-balance-sheet items and the overall quality of the company’s earnings will be scrutinized. Budgets and forecasts may be analyzed, especially if management prepared them specifically for the M&A transaction. Interviews with key personnel and frontline employees can help a prospective buyer fully understand the company’s operations, culture and value.

Artificial intelligence (AI) is transforming how companies conduct due diligence. For example, AI can analyze vast quantities of customer data quickly and efficiently. This can help identify critical trends and risks in large data sets, such as those related to regulatory compliance or fraud.

If a target company maintains an extensive database of customer contracts, AI can analyze every document for the scope of the relationship, contractual obligations, key clauses and the consistency of the terminology used in each document. Sophisticated solutions can analyze the target’s financial records and even produce post-acquisition financial statement forecasts.

3. Structuring the deal

Information gathered during due diligence can help the parties develop the terms of the proposed transaction. For example, issues unearthed during the due diligence process — such as excessive customer turnover, significant related-party transactions or mounting bad debts — could warrant a lower offer price or an earnout provision (where a portion of the purchase price is contingent on whether the company meets future financial benchmarks). Likewise, cultural problems — such as employee resistance to the deal or incongruence with the existing management team’s long-term vision — could cause a buyer to revise the terms or walk away from the deal altogether.

We can help

Comprehensive financial due diligence is the cornerstone of a successful M&A transaction. If you’re thinking about merging with a competitor or buying another company, contact us to help you gather the information needed to minimize the risks and maximize the benefits of a proposed transaction.

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