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Significance of Due Diligence in Mergers & Acquisition Transaction

Significance of Due Diligence in Mergers & Acquisition Transaction

Written by Amrita Sony

The due diligence phase of the mergers and acquisitions (M&A) process is crucial. Throughout the M&A process, it lets the buyer validate critical facts about the seller, like money, contracts, and consumers. After receiving this information, the buyer would be better positioned to make an informed decision and close the sale with confidence. After a Letter of Intent (LOI) is signed, due diligence normally commences.

MEANING OF DUE DILIGENCE

Any prospective buyer in a merger and acquisition transaction is potentially exposing themselves to severe risks. The acquisition might cause significant financial and reputational harm if the target fails to perform as expected or produces unexpected liabilities. As a result, a prudent acquirer will conduct a thorough and systematic evaluation of all areas of the target company’s business and industry before executing any transaction. This process is called Due Diligence. In other words, it is a process of verifying, investigating, or auditing a possible transaction or investment opportunity to ensure that all critical details and financial data, as well as anything else mentioned during the M&A deal or investment process, are verified.

OBJECTIVE/ SIGNIFICANCE

  1. Due diligence is performed to ensure that the buyer understands exactly what they are purchasing as well as any potential dangers that may occur as a consequence of the M&A transaction in order to avoid a disastrous business deal.
  2. It aids in the verification and confirmation of information provided during the deal or investment process.
  3. The procedure acts as a prerequisite before a formal agreement is executed as the facts obtained aids in the valuation of the transaction.
  4. Verifies that the investment or transaction satisfies the investment or transaction criteria.
  5. Physical examination of machines and equipment is required in the event of a production unit in order to evaluate the actual book value and operational condition of the plant and equipment.
  6. The due diligence process aids in determining the target company’s fair market value, which aids in determining the purchase price and payment method.
  7. Corporate governance, legal, and environmental compliance issues are identified during due diligence in M&A transactions.
  8. It serves as a warning to the investor, pointing out flaws in the target company.
  9.  Determines whether the M&A deal will result in any cultural differences.
  10. Proper due diligence can reveal unforeseen issues that can be resolved by the parties prior to signing a binding agreement.

STEPS UNDER IN DUE DILIGENCE

Due to the complex nature of M&A transactions, due diligence may take anywhere from a few weeks to months. The first stage is to put together a team that would be responsible for conducting due diligence.

To ensure a smooth transaction, the buyer will need a team of financial and legal experts with mergers and acquisitions experience. A due diligence team may comprise investors, auditors, attorneys, personal consultants, and maybe other service providers, depending on the industry.

The next step in the procedure is to gather important documents. The due diligence team creates a precise checklist that specifies which documents are necessary and when they should be presented. After signing a non-disclosure agreement, the due diligence team may access this information from the target company.

A meeting or series of meetings between the buyer and the target firm to negotiate the M&A transaction and document requirements may be scheduled. During these discussions, both stakeholders can better establish their compatibility, and the buyer can verify that the purchase is sound.

While the specific documents needed for due diligence differ based on the type of firm, its size, and other factors, there are a few sorts of information that are typically requested. Examples include corporate records, stockholder information, intellectual property contracts, and background litigation. Information about leases, regulations, insurance, as well as other financial matters, may also be obtained by the buyer.

In general, the buyer should learn everything there is to know about the targeted company’s financial health, operating resources, legal difficulties, and strategic position. The business contract may be terminated if any of the disclosed information presents a problem.

The next step in the due diligence process is to review all of the information provided by the target company. If the buyer has any concerns about the documents, now is the time for the acquirer to address them.

If the buyer is still unable to gain particular answers from the target company’s information, the buyer has the option of asking for extra information. The due diligence team will examine the documents for certain criteria, such as red flags,’ that could indicate a potential deal problem.

The team will determine whether the faults uncovered will result in the deal being cancelled outright or if the offer must be modified throughout the evaluation. The information revealed could, in some cases, change the structure or timeline of the deal.

To help speed up the process, the due diligence team may interact with the target company to resolve any concerns or concerns as quickly as feasible. Once the buyer is satisfied with the information provided and decides to move ahead with the transaction, the final step is to draw up a purchase contract and sent it to the target firm for approval.

The report should include a summary of any difficulties discovered throughout the due diligence process, as well as any aspects that were deemed satisfactory. The buyer will wrap up the report by giving his or her final opinion on the purchase. In many cases, the buyer will see the acquisition as a worthwhile investment and the transaction will go through as planned.

In other situations, however, the buyer will ask for the purchase to be changed as a result of their due diligence findings. If the issues prove to be very difficult to resolve, the buyer may choose to terminate the contract.

About the Author

Amrita Sony

4th-year B.Com., LL.B. (Hons.) student at Gujarat National Law University in Gandhinagar, Gujarat.

Keywords: Due diligence, Due diligence in Mergers, Mergers and Acquisition

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