Understanding mergers. and acquisitions is difficult because of its complexity. Nevertheless, you usually follow five steps from the beginning to the end of an M&A process.
Once you have defined that M&A is one of the strategic tools for long-term growth, the development of a target pipeline is next. After you analyze your targets with an M&A scorecard, you start with initial discussions, followed by a term sheet and Letter of Intent (LOI). Next comes a more detailed data analysis in the due diligence, which is the focus of this guide. You take this information and develop a business case and investment thes is value capture approach. Afterward, you continue with the negotiations and close the deal if you still believe that it creates value for your company. The operational integration comes after the closing in parallel with any required post-closing adjustments.
THE M&A PROCESS
1.Strategy Formulation and Pipeline Development
2.Initial Discussions with Target and Letter of Intent
3.Business Case and Due Diligence
4.Negotiation and Closing
5.Post-Closing Adjustments and Integration
INTRODUCTION TO DUE DILIGENCE
Due diligence, in a sentence, is the process of collecting and analyzing information from the M&A target company. In a broader sense, the due diligence definition is any kind of research and analysis of a company for a business transaction. It is a crucial step in the mergers and acquisitions process. Here are a few general tips to make the due diligence successful:
1.Build a due diligence team with people from different functions.
2. Combine internal teams with external experts.
3. Question everything in the reporting and planning assumptions.
4. Based on the due diligence findings, develop a business case and investment thesis/value capture approach.
5. In parallel with the due diligence, prepare an integration plan.
6. Organize check-ins to exchange information between teams.
7. Work closely together with the M&A project and negotiation leader.
DUE DILIGENCE TEAM
GET EXTERNAL HELP
DUE DILIGENCE AREAS
FINANCIAL DUE DILIGENCE
The main focus of the financial due diligence is on all facets of the accounting approach (i.e., accounting standards and policies), cash management (treasury), and the financial performance of the target company. The tax due diligence is a separate topic. Focus on the following issues:
- Use an external accounting firm and include a quality of earnings (QOE) report in the scope, which normalizes the reported numbers
- Understand first the business model, then the numbers.
- Focus on the cash flow, then the income statement and balance sheet; cash flow/income statement differences should be only due to timing => continuous big differences are a red flag.
- Think about what is missing in the numbers (because some companies adjust the reported financials).
- Don’t assume compliance with accounting rules; even big companies sometimes have poor quality of accounting.
TAX DUE DILIGENCE
Besides the legal due diligence, one of the technically more complicated topics is the tax due diligence because every country (and sometimes region) has different tax rules. Here are some examples from my M&A transactions that will help you with your next due diligence.
LEGAL DUE DILIGENCE
The legal due diligence process is one of the fundamental elements of the overall due diligence process. The reason is that every aspect of a company has at least some legal touchpoint. Whether you talk about employees or analyze assets and liabilities on the balance sheet, there is a legal topic that you need to address in the due diligence. Moreover, the legal due diligence must address issues that may arise during the due diligence from other workgroups and use those findings in the preparation of the M&A purchase agreements later in the process. Here are some tips for your next legal due diligence:
- Understand the regulatory environment in the target’s country
- Start with the analysis of the legal entity structure
- Go through all balance sheet and income statement items to identify legal topics
- Intellectual property (IP) is a big topic; work with an external expert on it
- Analyze past, ongoing, and potential litigation. Include Environmental, Social, and Governance (ESG); it is a growing topic with a significant impact
COMMERCIAL DUE DILIGENCE
- The commercial due diligence is another essential element of themergers and acquisitions process. It is at the heart of understanding the competitive market position of the target company and digs into otheraspects of marketing and sales. Here are a few topics:
- Define the addressable market and understand first the market and the target’s competitive position
- Continue with the business model and go-to-market strategy before digging into the numbers
- Get the details of the client list and revenue development assumptions
- Understand the target’s gross margin calculation because companies have very different approaches
- Benchmark marketing and sales costs for potential synergies
CONCLUSION
Due diligence can be a lengthy and complicated process; however, it is one of the most crucial elements in the M&A process, and there is no way around it. Based on your due diligence findings, you develop your business case and investment thesis/value capture approach. In parallel with the due diligence, you also work on the integration plan. An M&A process is a stage-gate process, meaning you have multiple go/no-go decisions throughout the process. The end of the due diligence is certainly one of those points where you need to decide whether you continue the process or not.
The good news is that you don’t have to reinvent the wheel. You probably have at least some employees who worked on M&A projects before, and there are experts that you can hire. You don’t have to do it alone.
