Role of due diligence in M&A transaction

Role of due diligence in M&A transaction

Due diligence is one of the most necessary and lengthy process that starts with the beginning of an M&A transaction and sometimes even continues post-close of the transaction. Due diligence is an evaluation process used by an interested buyer to dig deeper into the selling business and the risks attached to the company and deal. It is done to check whether the information stated in documentation referred to as a confidential information memorandum is relevant. Majorly, M&A transactions focus on intangible. The process involves checking financials and projections for the business, gaining a strong understanding of the business model; how the company conducts business, works with and services customers; vendor relationships; the talent of employees; and most essentially, how your business competes against other businesses in that industry.

Seller to better present their company tends to only the shining part in the company. But it is advised by the experts that the companies should showcase the real picture even if it includes some challenges in the business. Avoid the situation where a potential buyer will find out about potential problems in your business for the first time in due diligence. These issues should be disclosed with an executable plan that the company executives and advisors have made.

People tend to consider that the due diligence process is all about getting the best price from both seller and buyer's point of view. However, this process is more for the buyer to understand company operations. It helps understand synergies, potential scalability of the business with enhanced operations, and more accessible to customers from the buyer's company.

The seller is advised to have a business preparedness assessment conducted before engaging an investment banker on board. This can be done to identify potential value-detractors in the business, as well as assisting in the preparation of key documents, business plans, growth plans, and overall preparation for the M&A transaction.

The buyer along with advisors hired the conduct diligence process. The advisors will invest their time at the main headquarters of the target business, going through prepared information. These advisors can be a CPA firm for accounting and tax review, industry consultants to evaluate the company's business model and future opportunities, attorneys for legal review of the due diligence process, environmental consultants and labor attorneys, etc.

Below mentioned are the steps for M&A transaction:

1. Exit Planning is the process where the seller has decided to sell the business and is assembling the business and its financial aspects of the transaction to maximize enterprise value and after-tax proceeds while personally preparing the seller for the life transition.

2. Preparation is where the transaction team begins the process of accumulating information, preparing the strategic plan for the business, material contracts, reviewing audited financial and accounting reports and the CIM

3. Formal Marketing is where your investment banker will release teasers to potential buyers, negotiate confidential agreements, distribute the CIM to potential buyers, finalize the data room, prepare a detailed management presentation, engage bidders and collect letters of interest (LOI) from potential buyers.

4. Due Diligence & Final Bids is the step where the investment banker and team will assess and set the priorities of nonbinding bids, arrange bidders meeting for a management presentation, site visit and access to the data room, organize management meetings, set a deadline for offers with committed financing and circulate draft contracts.

5. Negotiation & Closing is where you receive firm offers with marked-up contracts, choose the best offer, negotiate the sell and purchase agreement and ancillary contracts, build the last round of final due diligence, execute the contract(s) and fulfill conditions leading up to closing (regulatory, accounting and legal). There are two rounds of due diligence: first round in which happens after the LOI is received and the potential buyer(s) are interested in moving forward. There is usually a price associated with the interested buyer when they send LOI. It is easy to see how due diligence can become a major reason for a transaction falling apart.


Due diligence is done in two places:

•    A data room

•    On-site with the business owner

A data room is a cloud-based centralized file-sharing system build by the seller or the buyer where data is stored for monitoring and reviewing. The data in the data room is regarding the requested information by the buyer. Third-party advisors representing the buyer will utilize the data room to conduct due diligence. In the case of ultra-sensitive documents, they may be withheld until later in the process. The data room has a file system that may be organized by financials, business plans, legal documents, growth plans, management presentations, etc. In round two of due diligence, the final part of due diligence, there is a need for third-party advisors to conduct due diligence on-site. This may involve environmental, labor, and business model/management due diligence.

Multiple ranges of net earnings before EBITDA is there while selling a business. Solid preparation and transition planning can increase offers to the higher end of the multiple ranges. Moreover, exit planning could add an "additional turn," or even higher multiple exceeding the top range of the multiple for the seller. Build a well-thought-out transition plan that will work to your advantage.