Due Diligence takes different forms depending on its purpose:
- The examination of a potential target for merger, acquisition, privatization, or similar corporate finance transaction normally by a buyer. (This can include self due diligence or “reverse due diligence”, i.e. an assessment of a company, usually by a third party on behalf of the company, prior to taking the company to market.)
- A reasonable investigation focusing on material future matters.
- An examination being achieved by asking certain key questions, including, how do we buy, how do we structure an acquisition, and how much do we pay?
- An investigation of current practices of process and policies.
- An examination aiming to make an acquisition decision via the principles of valuation and shareholder value analysis.
The Due Diligence Process (framework) can be divided into nine distinct areas:
- Compatibility audit.
- Financial audit.
- Macro-environment audit.
- Legal/environmental audit.
- Marketing audit.
- Production audit.
- Management audit.
- Information systems audit.
- Reconciliation audit.
Some of the primary reasons for conducting legal due diligence are outlined below.
- Better Understand Your Business. Legal due diligence is necessary to give the buyer the information that it needs to learn about your target company and to structure its purchase of your company.
- Help to Value the Target Company. The buyer will use the information learned in the legal due diligence process to determine how much to pay for your company.
- Help in Drafting the Relevant Documentation. The information learned in the legal due diligence process will be helpful for both the buyer’s counsel and your company’s counsel in drafting and negotiating the merger or acquisition agreement and related ancillary agreements.
- Identify Impediments to Closing. In the legal due diligence process the parties will attempt to identify everything that must happen before the transaction can close.
- Legal Opinions. Often the target company’s counsel, the buyer’s counsel or both will be expected to render a legal opinion at the closing of the merger or acquisition transaction.
5 keys Due Diligence Activites In A Merger And Acquisition Transaction
1. Financial Matters. The buyer will be concerned with all of the target company’s historical financial statements and related financial metrics, as well as the reasonableness of the target’s projections of its future performance.
2. Technology/Intellectual Property. The buyer will be very interested in the extent and quality of the target company’s technology and intellectual property.
3. Customers/Sales. The buyer will want to fully understand the target company’s customer base including the level of concentration of the largest customers as well as the sales pipeline.
4. Strategic Fit with Buyer. The buyer is concerned not only with the likely future performance of the target company as a stand-alone business; it will also want to understand the extent to which the company will fit strategically within the larger buyer organization.
5. Material Contracts. One of the most time-consuming (but critical) components of a due diligence inquiry is the review of all material contracts and commitments of the target company.