Imagine shaking hands on a seemingly perfect business deal, only to discover hidden problems later that unravel the entire agreement. This is a scenario that is all too common. According to Forbes, half of deals fall apart during due diligence. Due diligence, a meticulous investigation process, acts as the antidote to such pitfalls. It goes beyond the initial handshake, offering a deep dive into a potential partner or acquisition’s financial health, legal standing, market position, and internal operations. Spending the time to uncover critical information beneath the surface empowers informed decision making and mitigates the risk of any potential red flags. 

  

Key Areas of Due Diligence 

 

Financial Due Diligence 

This analysis dissects the target company’s financial statements, to assess profitability, cash flow, assets, and debt levels. Valuation methods are utilized to refine the price and deal terms, as well as identify any potential financial risks that could have future implications. Financial due diligence is critical in evaluating a company’s financial health and stability 

  

Legal Due Diligence 

This area serves to protect against potential legal pitfalls. Lawyers carefully scrutinize contracts, agreements, and regulatory compliance. It is their responsibility to uncover any hidden legal liabilities, intellectual property issues, and ensure that the deal is in line with all necessary regulations. Legal due diligence reduces the risk of any potential legal entanglement, by protecting your interests. 

 

Market Due Diligence 

Market due diligence plays a valuable role in evaluating the long-term viability of a potential deal. This stage involves researching the target market, analyzing industry trends and growth potential, as well as the company’s current customer base. This analysis goes beyond the surface level, delving into several key areas: 

  • Target Market Analysis: size, demographics, growth trends, customer needs, etc. 
  • Competitive Landscape: Who are the key players? 
  • Customer Analysis: Understanding current customer base 
  • Industry Trends & Growth Potential: Is the company’s industry growing or shrinking? 

Analyzing these aspects of market due diligence helps to assess the overall attractiveness of the market, the target company’s competitive edge, and its potential for future success.  

 

Operational Due Diligence  

This step requires a deep dive into the inner workings of the target company. It evaluates management capabilities, investigates the efficiency of internal processes, and assesses the company culture. This stage is critical for highlighting any potential inefficiencies, differences in cultures, and possible risks related to production or delivery. A full picture understanding of operational strengths and weaknesses gives the acquirer the necessary data to forecast synergies and predict integration challenges. 

  

Benefits of Thorough Due Diligence 

While time consuming and often expensive, the value of thorough due diligence far outweighs the cost. Mitigating risks and avoiding costly surprises is the key driver for this process. Undisclosed lawsuits, deteriorating financials, and risks to current customers are all items that can hide beneath the surface of a deal. While uncovering risks is the key necessity for due diligence, there is also the possibility to uncover hidden opportunities and/or synergies. An in-depth look at a company’s customers, operations, and market position can reveal post-close opportunities that were previously undetected. A precise comprehension of the additional value that can be attained by an acquirer can play a significant role when negotiating final terms. Valuations before and after due diligence rarely remain unchanged – the majority of deals get renegotiated. The findings of due diligence are a powerful tool in negotiating a better deal. Once risks have been identified, the acquiring company then has the information needed to renegotiate terms or walk away from a deal entirely. A great way to think about due diligence is as an insurance policy. 

 

Challenges of Due Diligence 

Proper due diligence can provide a wealth of knowledge, however, can be a challenging process to navigate. Formal diligence typically begins after an LOI has been submitted and accepted, and that is when the clock begins. The majority of LOIs for small businesses propose to close within 30 to 90 days, which is the acquirers’ time frame for diligence (of course this varies by deal). Thus, time constraints and deal pressure are a constant burden. M&A processes thrive on speed, which can lead to a rushed investigation during the diligence phase. Limited access to data can also complicate the process and even result in improper analysis. Even with confidentiality in place, companies are often hesitant to share their most sensitive data. Depending on the size and complexity of a deal, the cost of utilizing industry specialists, accountants, and lawyers can be very costly. People often take short cuts or skip a proper diligence process all together, which is a critical mistake. Potential acquirers need to find the balance between cost-effectiveness and a comprehensive analysis. 

  

Best Practices for Effective Due Diligence  

A defined path and strategy will help equip an acquirer to navigate the challenges of due diligence and ensure a smooth process. There are several fundamental best practices to keep in mind. 

  • Planning is Key: A precise roadmap and tailored plan that takes into account specific areas of the investigation is a necessity. A refined timeline will also allow you to track milestones through the process. 
  • Assemble the A-Team: Due diligence is not a solo act. Having an experienced team will allow you to effectively assess all aspects of the target company. Leveraging the varying expertise of your team will result in a well-rounded investigation. 
  • Embrace Technology: While still intense, the process of due diligence has become substantially more efficient in recent years with the constant developments in technology and recently even AI. These tools can store, organize, and even evaluate data (to an extent), as well as promote communication and collaboration. 
  • Communication is Critical: Acquiring a business is an intense process and selling a business is often an emotional process. This can be a tricky combination and can turn diligence sour very fast, so clear and efficient communication is vital.