In merger and acquisition (M&A) transactions, the terms of the deal are governed by the letter of intent. This is a non-binding document that contains the terms of the transaction between a buyer and a seller. Within these agreements, there is almost always a clause that permits the performance of due diligence of the target company.
The goal of due diligence is to verify all material facts that relate to the transaction, and buyers are permitted a finite time period to complete their evaluation. When performed effectively, the due diligence procedures can mitigate potential deal and post-close headaches. To maximize the diligence process, it is important to avoid some of the common mistakes in these types of engagements.
Common Mistakes in the Due Diligence Process
Poor buyer communication: Findings should be communicated quickly and clearly to the interested party upon discovery by the team performing due diligence. This gives the buyer adequate time to evaluate the issue and take the correct action as necessary. For example, the loss of a relationship with a major supplier could significantly alter the operational capabilities of the target company. Notifying the buyer in a timely manner will allow them to determine if the deal needs to be restructured.
Inadequate internal coordination: The diligence process often encompasses a realm of functional areas of an organization, involving financial, legal, and compliance teams. To keep things moving smoothly, there needs be a fluid flow of information throughout the engagement. This can often be accomplished by assigning a project manager on the due diligence team to the engagement to accumulate findings and evaluate the status of each task.
Losing sight of the goal: It is easy to get caught up in the details when performing procedures, but one must take a step back and assess the importance of each task. Ultimately, the procedures should be designed to achieve maximum value for the buyer. The cost/benefit of each step should be evaluated to make the best use of the limited time available for the diligence process. For instance, an unrecorded liability search could be a waste of time in an asset purchase. Since the liabilities of the company often do not transfer to the buyer, it would not be necessary to evaluate their completeness.
By maximizing the due diligence process, some of major problems associated with transactions can be avoided. This includes not only the associated costs of overpaying for the business, but also incremental costs that might be incurred due to changes in customer relationships, suboptimal capital structure or regulatory risks that have not been accounted for ahead of the deal.
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Material discussed is meant for informational purposes only, and it is not to be construed as investment, tax, or legal advice. Please note that individual situations can vary. Therefore, this information should be relied upon when coordinated with individual professional advice.