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Due Diligence

5 chapters

Due Diligence M&A

In the context of mergers & acquisitions, due diligence is the process of auditing/evaluating a potential target company by getting its financial, legal...

Mergers and Acquisitions is an important way for companies to grow and become stronger and better organizations. Even though Mergers and Acquisitions have several advantages, but the risks involved are equivalent too. The real motive behind mergers or acquisitions should be made clear for all the parties concerned to ensure real success of such merger or acquisition. The post implementation phase is a very critical part where several mergers or acquisitions fail and before onset of any deal, most companies should conduct due diligence to ascertain the real risks and profitability of such deals.

Definition: In the context of mergers & acquisitions, due diligence is the process of auditing/evaluating a potential target company by getting its financial, legal, commercial and other relevant information from the company, before finalizing the deal.

The main idea behind conducting due diligence is to make sure that there are no hidden information associated with the transaction under consideration. Failure to carry out due diligence prior to entering into a deal of enormous proportions could lead to situations where the asset under merger/acquisition possess certain hidden liabilities which get automatically transferred to the acquirer. While some may argue that the cost associated with performing due diligence is on the higher side, the importance of conducting a thorough investigation of the business before making a deal cannot be neglected under any circumstances. To any company involved in merger or acquisition, the due diligence investigation will attempt to reveal all material facts and potential liabilities relating to the target company/unit/business. The purpose of due diligence is to confirm that the business actually is what it appears to be. The information learned while conducting due diligence will further help in drafting and negotiating the transaction agreement and related ancillary agreements.

When a company is considering the acquisition of a target, the purposes of a due diligence investigation include:

  • To determine the appropriate purchase price to be paid by the acquirer, and the method of payment;?
  • To determine details that may be relevant to the drafting of the acquisition agreement;?
  • To evaluate the legal and financial risks of the transaction; ?
  • To evaluate the condition of the physical plant and equipment as well as other tangible and intangible property to be included in the transaction; ?
  • To analyze any potential antitrust issues that may prohibit the proposed merger or acquisition; ?
  • To determine compliance with relevant laws and disclose any regulatory restrictions on the proposed transaction;?
  • To discover liabilities or risks that may be deal breakers. ?

There are three main categories of due diligence are financial, legal and commercial. The best due diligence programmes always maintain a balance of these elements as the work in one area can often inform the checks being carried out elsewhere.

  • Financial
    Financial due diligence focuses on verifying the financial information provided and to assess the underlying performance of the business. The areas covered under financial due diligence include earnings, assets, liabilities, cash flow, debt and management, to name a few.


  • Legal
    Legal due diligence aims to examine the legal basis of a transaction, to ensure that a target business holds or can exercise the intellectual property rights that are crucial to the future success of the company. The areas included in legal due diligence are legal structure, contracts, loans, property, employment and pending litigation.


  • Commercial
    Commercial due diligence considers the market in which a business operates and it involves conversations with customers, an assessment of competitors and a fuller analysis of the assumptions that lie behind the business plan. All of this is intended to determine whether the business plan stands up to the realities of the market.

Below are detailed steps for individual investors undertaking due diligence.

  • Understanding the compliance concerns
    The corporate world is constantly evolving and with that, the number of regulations imposed on organizations also keep on increasing. Hence the business must have an understanding of the compliance they need to adhere to.
  • Defining the necessary corporate objectives
    The due diligence process needs to align with the regulatory, strategic, reputational and financial risks which the business could face.
  • Gathering necessary and important information
    All the information pertaining to the business under consideration has to be collected and with utmost care, too. This should include the financial and legal information about the company as well as information regarding the board members of the company, its key shareholders, its incorporation documents, the company’s political connections (if any) and so on.
  • Analyze the total value of the company

The first step in analysing a company’s total value is determining how big the company is. One way to determine this is to check the company’s market capitalization, which gives an idea about how volatile the company’s stock will be and the potential size of the company’s market.

  • Analysing the revenue, profit and margin trends
    Having a clear idea about a company’s gross revenue, profit margins and return on equity trends is extremely necessary in any kind of investment, be it a merger or an acquisition. The recent trends in the revenue will give an idea about whether the growth is constant or fluctuating and in the case of latter, if there are ay major jumps or falls. Reviewing the profit margins is essential to see if they are rising, falling or remaining constant over the years.
  • Analysing the competitors and industry
    Once the acquirer is done analysing the financials and other crucial information about the target business, the next step is to scale up the industries it operates in and who it competes with. One of the best ways to analyse a company is by studying its competitors. Having a look at the major competitors will help the acquirer to narrow down how big the market is for the target’s products/services.   
  • Conducting a thorough risk assessment
    A risk assessment of the target company has to be prepared. The assessment should consider points such as the extend of government involvement, country risk and/or financial risks arising due to internal factors.

1. Even though due diligence is a lengthy and time consuming process, it is a crucial part in any merger and acquisition deal that determines whether the deal is worth the money and effort or not.

2. A due diligence report detects issues that can be tackled early in the process.

3. The findings of a due diligence process can provide the acquirer with information that is essential to determine the true value/cost of the business under consideration.

4. The due diligence report also contributes towards the formulation of the deal and enables a hassle-free negotiation.