Acquiring companies go through a due diligence exercise to help ensure there are no surprises after the deal closes. The due diligence typically takes place once an offer has been accepted by the acquiring company, pursuant to number of conditions being fulfilled, one of which would be the completion of the due diligence.
Many companies require organizations to provide assertions, which become part of the purchase agreement. These declarations provide a framework that allows the acquiring company to take legal action against the owner if it is not consistent with the business practices. For example, the purchase agreement might state that all client contracts do not have an exit clause on ownership transfer. If subsequent to the close of the deal, it is determined there were a number of contracts that did have exit clauses, it could provide grounds for litigation against the owner.
The acquiring company may deploy a team onsite, or provide the owner with a list of information they want to inspect. This will become a time consuming exercise, if the information requested is not readily available. There are 7 main areas of due diligence where companies will focus on. Below is a summary of each area, along with a brief description of some of the activities that will take place.
Sales and Marketing
Activities that would be included here would be focused on the sales and marketing process along with the methodology relating to the forecasting approach that will feed into budget. As any valuation of the company would look at the future forecasted revenue streams, the acquiring company would want to be comfortable with how the forecast is put together. Furthermore, understanding the sales and marketing group will help the acquiring company in determining the areas of overlap within their organization and help assess the quality of the team.
Understanding the operations of the company will assist the acquiring company assess the overall day to day operations of the acquired company. The steps related to client on-boarding would be reviewed, along with the ongoing activities with the client. The project management approach relating to client on-boarding is reviewed here, to determine the risks associated to implementing new clients. Other activities such as account management, support levels and client turnover are reviewed.
An analysis of the financial statements is performed to understand the assets/liabilities, along with the types of revenue and expense. As the financials tie in directly to many areas of the business, there is often overlap between this area, and that of the other review teams. A properly structured due diligence team will manage this in an efficient manner. For example, the pricing of products is normally a marketing function, but the profitability of products has a direct relationship to the profitability of the company.
Depending on the size and type of organization, this level of effort here can vary significantly. If the company is a public organization or has activities in multi-jurisdictions, the review here would include a number of activities. A review of SOX Compliancy would often be a topic for this section. Transfer pricing would be reviewed in the case of multi-national organizations. Tax filings compliance would be covered here as well, and would include both corporate and State/VAT taxes.
Understanding the company’s infrastructure is important. Items like real estate, corporate networks, both network and physical security and others would be discussed to understand incompatibilities and identify areas of vulnerability.
The people in a company is a key component of any acquisition. It is critical for an acquiring company to understand the employee policies and procedures that are in place. Furthermore, key resources are identified and the plans in place to reduce turnover of those individuals are reviewed here. Turnover statistics are analyzed as well to help identify any potential staffing risks.
This is another critical area of review and covers many areas. Most of the key client/supplier contracts are reviewed, along with the letters of incorporation, board meeting minutes and employment agreements. Any outstanding litigation or recently settled litigation is reviewed as well.
Once an agreement in principle has been reached, both parties will want to bring the deal to conclusion as soon as possible. As a result, the due diligence phase will be on a tight timeline. It is important that the acquiring company is organized and is prepared for this phase. The inability to provide information to the acquiring company on a timely basis can cause the deal to collapse.
As a result, companies wanting to sell their business should ensure they are prepared internally for this step, well in advance of the sale. As part of the annual planning process, companies should perform a readiness assessment and determine if there are areas that need to be addressed. While a company can not anticipate everything that may arise during the due diligence process, most of the potential issues can be alleviated.