Due diligence is the cornerstone of successful M&A transactions, involving a meticulous review of the target company to identify current and emerging risks, uncover opportunities, such that the buyer can assess holistically as best as possible its true value to the buyer. The process, while essential, is fraught with challenges that can derail even the most promising deals. Below, we delve into the intricacies of due diligence, its common pitfalls, and the roles of key players, particularly on the seller side.
Core Components of Due Diligence
All transactions differ and are informed by the buyer and seller circumstances and that of their respective advisors, who will often conduct the majority of the diligence workstreams. Due diligence workstreams can span various areas, including:
- Financial: Analysis of historical financial performance, projections, and debts
- Legal: Examination of compliance, pending litigations, and intellectual property
- Operational: Understanding processes, controls & workforce dynamics
- Commercial: Review of the products, services, customers, markets & peers
- IT and Cybersecurity: Evaluating robustness of IT infrastructure and data security
Mechanics: Tools and Processes
The Information Request List (IRL)
An IRL is the backbone of due diligence, systematically listing documents and data required from the seller. It ensures no critical aspect—be it financial reports, contracts, or regulatory compliance documents—is overlooked. The comprehensiveness of the IRL directly impacts the quality of the diligence and these forms can often run to hundreds of items, often taking some weeks for sellers to collate, answer and share.
The Data Room
A virtual data room (VDR) facilitates secure sharing of sensitive information. This centralised repository, often instigated by the sellers lawyers, not only organises documents but also tracks access, ensuring transparency & confidentiality with what are often highly sensitive commercial and private records.
Roles of Advisors
Advisors are indispensable in navigating the due diligence process. Their familiarity navigating similar exercises will ensure that sellers and buyers are appropriately advised and successfully project management an in-depth, time consuming and often disruptive process:
For the Buyer:
- Preparing an appropriate scope of works which satisfies the requirements of both the buyer and their financial stakeholders
- Reviewing and validating seller-provided information
- Interpreting complex findings, such as technical audits or legal risks
- Identifying issues requiring additional warranties or indemnities in the Sales and Purchase Agreement (SPA)
- Conducting negotiations with the Seller resulting from the above
For the Seller:
- Assisting to prepare the Seller for what to expect regarding the depth and breadth of information required and what remediating actions are required to make the base records comprehensive and fit for purpose
- Ensuring the accuracy and consistency of responses
- Preempting buyer concerns and building information supporting the Seller
- Mitigating risks by strategically addressing & negotiating sensitive areas
By facilitating the flow of information, communicating and clarifying uncertainties, advisors help both parties reach informed decisions whilst protecting their respective interests.
Common Mistakes in Due Diligence
Despite its importance, mistakes made in due diligence can often compromise a transaction:
- Rushing the Process: Hastily conducted diligence often fails to serve the interest of both buyer and seller
- Prolonged Timelines: Excessive delays can cause deal fatigue with the buyer and (or) seller
- Lack of Preparation: Unorganized sellers struggle to provide coherent, accurate information and in doing so reduce their credibility and negotiating leverage
- Piecemeal Responses: Disjointed answers from sellers limits the pace at which workstreams can be completed and can create confusion
- Stakeholder mgmt: Too many stakeholders on either side can lead to delays, inefficiency, disconnected and conflicting priorities
- Ignoring Materiality: Focusing on immaterial issues can detract from addressing much more significant & strategic risks, as well as create delays in the process
- Poor Communication: Deals are invariably built on trust, confidence and rapport - failing to communicate swiftly, with empathy and professionalism often drives fatigue
- Underestimating Issues: Sellers often fail to anticipate the severity of certain matters, leading to frustration and a lack of credibility later in the process
- Incomplete or Contradictory Information: Inconsistent, incorrect or multiple versions of answers can damage credibility and only leads to a protracted process
- Repeating Questions: With multiple scopes of work all Sellers get frustrated by having to answer the same or similar questions - especially acute the longer the process runs
Avoiding these pitfalls requires careful planning, collaboration, and the involvement of experienced professionals. Often all parties are assisted by early scoping/discovery calls and sharing of information that prepares all parties for the work ahead.
The Seller's Perspective
Key Participants
From the seller's side, participants typically include:
- Executive Management: Providing strategic oversight and direction
- Legal Counsel: Addressing compliance, contracts, and regulatory issues
- Financial Officers: Ensuring accurate and complete financial disclosures
- IT Specialists: Handling technical audits and infrastructure evaluations
Confidentiality Concerns
Sellers often aim to insulate day-to-day operations from the due diligence process to maintain confidentiality. This minimises the risk of unsettling employees, customers, or competitors who might misconstrue the implications of an ongoing deal.
By limiting the flow of sensitive information to a small, trusted group and utilising secure tools like VDRs, sellers protect their business integrity while fulfilling buyer requirements.
From Due Diligence to SPA
The findings of due diligence influence the terms of the Sale & Purchase Agreement (SPA), addressing identified risks through:
- Warranties: Seller assurances about the state of the business
- Indemnities: Provisions requiring the seller to cover specific liabilities
This alignment of findings with contractual safeguards ensures that risks are effectively mitigated post-transaction.
Conclusion
Due diligence is a multifaceted process requiring rigorous planning, effective tools like the IRL and VDR, and the expertise of advisors. Avoiding common mistakes, communicating regularly and maintaining confidentiality are essential for a smooth transaction. Sellers and buyers, supported by their teams, must work collaboratively to identify material risks, address them proactively, and lay the groundwork for a successful future integration.