Your Guide to M&A Due Diligence Preparation

July 2, 2020 Financial Strategy

There’s rarely a sign with big red letters warning us of the need for due diligence during an M&A. But maybe there should be.

83% of mergers and acquisitions (M&A) fail. But with some preparation, it’s possible to join the minority of successful M&A transactions.

M&A is a term that describes the combination of two businesses. As the buyer, the idea is to implement strategic goals through an acquisition rather than grow organically. On the other hand, M&A is an opportunity for a seller to cash out or raise funds and share the risk and reward of a new business.

Successful M&A provides value to buyers and sellers. But buyers have the opportunity to:

  1. Bring their products or services to market faster with new products and channels
  2. Lessen competition by purchasing a competitor’s market share
  3. Establish supply chain efficiencies when purchasing a supplier or customer

However, while both the buyer and seller can get what they want out of an M&A, the transaction isn’t always successful. The value of a business can become damaged during an M&A, and without due diligence, overestimating the potential cost savings can result in failure on the buyer’s part.

With failure a possibility, buyers usually prefer to perform in-depth due diligence. If they see something they don’t like, it’s possible they’ll move on from the deal without making a purchase. The key here is to make it as easy as possible for the buyer to determine your company is worth the investment.

This is where diligence is crucial for a successful transaction. By facilitating a comprehensive appraisal of assets and liabilities and an accurate analysis of your company’s commercial potential, you can increase your chance of a successful M&A.

The Importance of a Virtual Data Room (VDR) During an M&A

Today’s corporate environment has produced three significant trends to consider. First, technological advancements now redefine the way companies conduct business. Second, the global M&A transaction volume is increasing by an average of 37 percent each year, highlighting how corporate executives commonly use these transactions to achieve short- and long-term strategic objectives. And third, cross-border M&A activity is on the rise as a result of globalization.

With these trends in mind, nearly 20 percent of all executives involved in an M&A deal feel that due diligence is essential to the success of a deal. The crucial nature of a VDR is to enable the buyer to analyze the target’s risks, overall strategic fit, and potential combination benefits. Having this information readily available ensures a buyer finds the answers to these concerns during the due diligence process of the transaction.

The VDR digitizes the physical data your buyer needs to make an informed purchase decision. Documents stored in a VDR have a more efficient and effective presentation in digital format. It’s also possible to provide access to a VDR to multiple buyer teams as well as several potential buyers simultaneously.

For a buyer, a VDR offers cost savings, time savings, comfort, transparency, and a fair playing field. On the other hand, the seller benefits from a VDR’s simplicity, ease of setup, cost savings, competitive price, legal compliance, time savings, and security. In essence, the VDR facilitates the M&A transaction for both the buyer and seller.

M&A VDR Preparation Checklist

Any company interested in fundraising (debt or equity) for or selling their company should have a VDR containing all of their (corporate/financial/legal/operational) information for the due diligence process.

Here’s a checklist highlighting some of the documents and information most commonly requested during an M&A transaction:

1. Corporate Records – These documents generally include Articles of Incorporation (as well as all amendments), the Bylaws (as well as all amendments), Corporate Minute Book (along with all meeting minutes and resolutions of executive committees, shareholders and directors, and other governing groups), a list of shareholders (and the number of shares each shareholder holds), and an organizational chart.

2. Financial Statements – Your financial statements should include the three most recent sets of the following: balance sheet, income, and statement of cash flows; monthly or by shortest regular accounting period close; as well as key performance indicators and management discussion and analysis.

3. Audit of Financial Statements & Internal Controls – This documentation should include the most recent audit of your financial statements and internal controls, if available. Also, it’s ideal to include CPA-reviewed or -compiled financial statements, if possible.

4. Tax Returns – It’s best to have the last three years of tax returns, along with all schedules and corresponding financial statements on hand.

5. Fiscal Policies & Procedures – Your provided fiscal policies and procedures should include all related processes. This can include payroll processing, accounts payable, purchases, bank reconciliations, accounts receivable, and more.

6. Significant Contracts – Consider any and all significant contracts that relate to your company’s equity rights, leases, debt, employees, customers, suppliers, professional service providers, legal settlements, and anything else that could impact the company.

7. Annual Budget – Including your current and prior annual budget, along with sales, financial, and other forecasts, is also ideal for your potential buyer’s analysis.

8. Plans & Guidance – All plans and guidance associated with your company should be available. This includes the company’s business plan, executive summary, strategic plan, and any other general guidance that could prove beneficial for analysis.

9. Accounting Books – Staying up to date on your accounting and having a copy of or access to the accounting information system database on hand is a sure-fire way to provide insight into your company’s finances. This could include QuickBooks, Sage, Oracle, or some other accounting software.

The Goal: Facilitating the Valuation of Your Company

By performing M&A due diligence, buyers and investors can conduct an analysis to accurately value a company or its assets. The valuation approaches utilized during an M&A transaction can include analyzing the future cash flows (income approach), the value of the company’s assets (asset approach), and/or the value of similar companies (market approach).

Each potential buyer’s due diligence requirements differ in accordance with which valuation approach(es) they plan to use. Since it’s possible to simplify due diligence and increase tax and strategic advantages, many of these M&A deals convert into asset sales instead.

Whether the M&A will change or not, each party must prepare to ask and answer all questions pertaining to the valuation of the company. This, of course, includes providing information to support any of the valuation approaches that might be used.

Regardless of how your M&A might change, as the seller, it’s crucial to focus on providing the right information to allow the buyer or investor to appropriately value your company. While keeping the best possible outcome in mind can help you achieve the best deal possible, it’s equally important to consider the other party’s needs to successfully complete the M&A transaction.