The term “due diligence” can mean different things in different situations. For a person making a personal purchase, like a used car, performing due diligence might mean researching a model’s safety ratings or getting a mechanic to do an inspection.
With mergers, acquisitions, financings and other business transactions, though, due diligence is much more complex, and for good reason. Deals often involve a significant amount of money, are extremely detailed and impact many stakeholders — among them the principals of the deal, lenders and outside investors.
Although it’s a daunting and at-times tedious process, due diligence’s importance can’t be understated, providing an opportunity for both sides to prudently enter into a business transaction after examining all the necessary details.
Perform due diligence before the letter of intent
Due diligence isn’t a one-and-done activity — it involves answering questions of increasing granularity as a deal progresses over a period of several months. In mergers and acquisitions, some of these take place before business terms are agreed, usually confirmed in the letter of intent. This is generally referred to as business due diligence.
- Initially, both parties need to decide if a deal combining the two operations is justified by a plausible business strategy. At this stage, only a high level of background is needed to believe in the basic reasoning behind this plan.
- The next level of due diligence is to examine how likely the deal is to be successful. That involves analyzing the financial trends involved in the business, the customer or market justification for the deal, and any potential operating risks.
- Next, both parties must gather enough details to be able to outline a transaction in both qualitative and quantitative terms — assuming, at this stage, that the information provided is true.
What to expect during confirmatory due diligence
After a deal’s business terms are agreed upon in the letter of intent, the actual legal transaction requires a much more precise level of due diligence. At this point, the parties must confirm that the terms they’ve tentatively agreed to are rooted in verifiable facts. This phase, called confirmatory due diligence, involves getting answers from the other party for hundreds of questions.
In this stage, a core team of experts is always involved to perform due diligence:
- An accountant who examines financial reports and tax documents to confirm that the principles of accounting were applied appropriately and accurately,
- An attorney who focuses on legal matters and compliance (reviewing contracts, for instance, to verify a business’s client roster), and
- An investment banker or broker who manages the process and provides guidance about the fairness of the deal’s business terms.
Other specialists are often called in as needed. For instance, if there’s real estate involved, and the current owners have attested that the land has no environmental problems, an expert in environmental matters might be called in to verify that fact.
How to be strategic during due diligence
It’s vital that both parties in a transaction are totally candid and act with absolute integrity during due diligence. Having said that, there’s a right way and a wrong way to navigate the process.
While performing due diligence, provide the information needed for the current stage of decision-making only, not for the full transaction. Position everything as part of a story about the business, providing any supporting information that helps demonstrate that story.
It’s not unusual for a person with the responsibility for conducting due diligence to wonder if they’ve done a sufficient amount of investigation. Along the way, they may face pushback from the other party, who might think they’re probing way too deeply.
The best way to have confidence in due diligence is by following a recognized process with a defined list of questions, and steadily pursuing an answer to every question, even those best answered “not applicable.” We encourage both buyers and sellers to have patience and realize that the other party is simply trying to establish a level of assurance for stakeholders that allows them to enter into a transaction comfortably.
How Oaklyn Consulting assists with due diligence
Because our experience in business M&A transactions stretches back more than two decades, we at Oaklyn Consulting have developed a finely tuned radar for the common hurdles that can arise during due diligence.
We have a comprehensive awareness of what questions a shrewd buyer or seller would want to have answered before entering into a transaction. We follow a standard due diligence procedure involving more than 500 questions — and while it’s exhaustive, this thoroughness gives us and our clients confidence. Functioning as a project manager, we know which experts to call in and how to organize the priority of those calls to keep the process on track.
If you’re thinking about buying or selling a business, we’ll work diligently to make sure you’re entering into a transaction that you and your stakeholders can feel secure about.