Due diligence is an integral part of business mergers and acquisitions.
Mergers and acquisitions (M&A) due diligence is the process of investigating a company’s financial, legal, regulatory and operational viability before purchasing it. Business owners are required to submit documents and provide written responses to questionnaires to satisfy the buyer’s need to exercise proper care when executing a major transaction. The M&A due diligence label is normally reserved for large-scale complex corporate transactions and the investigation is conducted by law firms, but the logic behind the process is applicable to the purchase of any company, regardless of size.
M&A stands for mergers and acquisitions, which involve the sale and purchase, as well as corporate financing, of companies and organizations.
In the corporate context, an acquisition happens when one company buys another. The acquired company continues to operate under new ownership or is absorbed by the buyer and ceases to exist. In a merger, two companies agree to combine operations to form an entirely new company. The individual companies cease to exist and a new company is formed to move forward with the combined assets. Mergers and acquisitions due diligence may require the production of information by one party in the case of an acquisition or by both parties in the event of a merger.
Due diligence includes examining whether companies involved in a merger or acquisition have compatible cultures, leadership, strategies and competencies.
Due diligence is a legal standard that requires buyers to exercise caution when entering into transactions. This duty of care falls on the buyer to ensure that the transaction is legitimate, financially viable, of sufficient value and legally binding. Corporate buyers, in particular, must meet this standard because officers and directors are acting on behalf of a variety of shareholders, to whom they have an additional duty to maximize the value of their investments. If the buyer needs to void the transaction because of fraud or any other material misrepresentation, the court will consider whether or not it has conducted a reasonable investigation into the feasibility of the transaction before allowing the buyer a legal remedy.
M&A due diligence is conducted by lawyers in the period of time between the announcement of the deal and the expected date for closing the deal, which can be up to 18 months. The deal will not close unless due diligence is completed to the satisfaction of all parties. Acquisitions require a thorough financial investigation. The seller will have to produce documents such as financial records, important contracts and corporate filings, and answer questions on a wide range of matters, including outstanding legal matters, governmental and regulatory affairs and shareholder information.
Mergers typically require the additional step of conducting organizational due diligence to determine whether the two companies’ cultures are compatible. This type of investigation evaluates the company in terms of leadership, strategy, competencies, structure, process and work philosophy. Mergers and acquisitions due diligence on organizational issues tries to avoid a later realization that two companies have such divergent cultures that merging them would diminish the value of one or the other.