Best practices for M&A due diligence

The due diligence process is extensive and serves not only to evaluate the fairness of the sale price but also to confirm the seller’s claims, check the compatibility of the target, and ensure adherence to legal and regulatory standards, both before and after finalizing the deal. Below is a brief outline of the three main stages of due diligence.

1. Scope Definition

The first step in due diligence involves setting clear goals. This stage should involve an initial evaluation of the target's market standing and financial health, along with the anticipated benefits of the deal. Identifying and documenting the potential risks of the transaction is also essential, as this will guide the due diligence in verifying, assessing, and reducing the buyer's risk exposure.

2. Execution of Due Diligence

At this stage, the focus is on analyzing the target company's financial records, tax filings, legal documents, and financing structure. This includes examining contingent liabilities, items not listed on the balance sheet, and the overall quality of earnings. Budgets and projections, particularly those prepared for the M&A deal, are also scrutinized. Engaging with the company’s key staff and frontline employees offers insights into the company’s operations, culture, and value.

Artificial intelligence (AI) is revolutionizing the due diligence process. AI can efficiently process large volumes of customer data to identify significant trends and risks, such as those related to compliance or fraud.

For targets with extensive customer contract databases, AI can review each document for relationship scope, obligations, key terms, and consistency in terminology. Advanced solutions can also analyze financial records and predict post-acquisition financial performance.

3. Deal Structuring

The information collected during due diligence aids in formulating the terms of the transaction. For instance, discoveries like high customer churn, significant transactions with related parties, or growing bad debts might lead to a reduced offer price or an earnout clause (where part of the purchase price depends on future financial performance). Similarly, cultural issues, like employee opposition or misalignment with the existing management's vision, might prompt a buyer to modify the deal terms or reconsider the transaction.

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Effective financial due diligence is key to a successful M&A transaction. If you're considering a merger or acquiring another company, we can provide assistance in gathering crucial information to minimize risks and maximize the benefits of your proposed deal.

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