Engaging in a merger or acquisition (M&A) can help your business grow but can also be risky. Buyers must understand the strengths and weaknesses of their intended partners or acquisition targets before entering into the transactions. A robust due diligence process does more than assess the reasonableness of the sales price. It also can help verify the seller’s disclosures, confirm the target’s strategic fit, and ensure compliance with legal and regulatory frameworks — before and after the deal closes. Here’s an overview of the three phases of the due diligence process.
- Defining the scope.
Before the due diligence process begins, it’s important to establish clear objectives. The work during this phase should include a preliminary assessment of the target’s market position, financial statements, and the expected benefits of the transaction. You should also identify the inherent risks of the transaction and document how due diligence efforts will verify, measure, and mitigate the buyer’s potential exposure to these risks.
- Conducting due diligence.
The primary focus during this step is evaluating the target company’s financial statements, tax returns, legal documents, and financing structure. Additionally, contingent liabilities, off-balance-sheet items, and the overall quality of the company’s earnings will be scrutinized. Budgets and forecasts may be analyzed, especially if management prepared them specifically for the M&A transaction. Interviews with key personnel and frontline employees can help a prospective buyer fully understand the company’s operations, culture, and value.
Artificial intelligence (AI) is transforming how companies conduct due diligence. For example, AI can analyze vast quantities of customer data quickly and efficiently. This can help identify critical trends and risks in large data sets, such as those related to regulatory compliance or fraud. If a target company maintains an extensive database of customer contracts, AI can analyze every document to determine the scope of the relationship, contractual obligations, key clauses, and the consistency of the terminology used in each document. Sophisticated solutions can analyze the target’s financial records and even produce post-acquisition financial statement forecasts.
- Structuring the deal.
Information gathered during due diligence can help the parties develop the terms of the proposed transaction. For example, issues unearthed during the due diligence process — such as excessive customer turnover, significant related-party transactions, or mounting bad debts — could warrant a lower offer price or an earnout provision (where a portion of the purchase price is contingent on whether the company meets future financial benchmarks). Likewise, cultural problems — such as employee resistance to the deal or incongruence with the existing management team’s long-term vision — could cause a buyer to revise the terms or leave the deal altogether.
Comprehensive financial due diligence is the cornerstone of a successful M&A transaction. If you’re considering merging with a competitor or buying another company, contact us to help you gather the information needed to minimize the risks and maximize the benefits of a proposed transaction.
Contact us to discuss your M&A needs. Connect with our experienced Audit Partner, Dan Harris, for further insights into the due diligence process.
Reynolds + Rowella is a regional accounting and consulting firm known for a team approach to financial problem solving. As Certified Public Accountants, our partners foster a personal touch with our clients. As members of DFK International/USA, an association of accountants and advisors, our professional network is international, yet many of our clients have known us for years through the local communities we serve. Our mission is to operate as a financial services firm of outstanding quality. Our efforts are directed at serving our clients in the most efficient and responsive manner possible, delivering services that exceed the expectations of those we serve. The firm has offices at 90 Grove St., Ridgefield, Conn., and 51 Locust Ave., New Canaan, Conn. For more information, please contact Elizabeth Bresnan at 203.438.0161 or email.
