Understanding due diligence

Due diligence is the process through which a buyer fully understands the risks and opportunities of a merger or acquisition. Due diligence occurs after buyer interest and initial fit are confirmed and a non-disclosure agreement is signed to ensure that information is disclosed in commercial confidence. 

Through the due diligence process, the buyer can learn more about the culture, people, financial performance and operations of the target company. 

The process of undertaking due diligence involves sharing a lot of information and creating reports that reflect the risks and opportunities uncovered. The due diligence process can be structured in six steps. A definitive due diligence checklist can help to ensure no aspect is overlooked. Finally, some examples of due diligence give an overview of the types of information to request or share. 

Experience how Ansarada Deals™ can streamline due diligence processes. Explore the tools that make due diligence straightforward. —start for free today! 

Due diligence process in mergers and acquisitions

In a merger or acquisition, due diligence is when a target company is examined closely by a prospective buyer. The due diligence process is a structured approach to carefully examining every part of the business, including financial performance, market position, company culture, talent and operations.

Steps in the due diligence process

Due diligence is comprehensive and covers more than just the financial state of the company. The various types of due diligence undertaken during M&A include:

• HR due diligence considers company culture, fit, structure, talent and readiness for change. 
• Financial due diligence focuses on past financial performance, verifying and auditing the financial statements for accuracy and sustainability. 
• Legal due diligence considers legal relationships with stakeholders and regulators, licencing, contracts and pending liabilities. 
• Intellectual property due diligence analyses intellectual property and how this can benefit the merger or acquisition. 
• IT due diligence considers the technology and software used for suitability, scalability and post-merger integration. 

These types of due diligence follow a similar process. The due diligence process can be streamlined, automated and tracked for full visibility during the deal. 

While a lot of due diligence can be completed through reviewing documentation, some types, like operational or HR due diligence, may benefit from visiting the company’s site and speaking with employees to gather information for the final reports. 

This seven-step due diligence process applies to all types of due diligence: 

1. Set the goals of the merger or acquisition

At the beginning of the due diligence process, the buyer (and seller) should articulate what it hopes to gain from the deal. Setting clear goals for the merger or acquisition will inform the focus of the due diligence process. 

The buyer’s goals for M&A might be to acquire intellectual property, entry to a new market or expand market share. The seller may want to ensure continuity for employees, realize a profit or create synergistic opportunities. Once the goals are set, due diligence can be tailored to focus on any risks and opportunities relating to the goals. 

2. Request and prepare documents

Preparing for due diligence can begin long before the deal begins. The target company of M&A can begin preparing early, or adopt an ‘always on’ approach. This ensures that the key financial, operational, legal, tax and HR data is always up-to-date and reportable. 

Sellers can ensure their information is complete and well structured by downloading Ansarada’s free, definitive due diligence checklist.

The prospective buyer will research the target company, with the set goals in mind, to ensure that they request all material information about intellectual property, potential legal or compliance issues, financial information and so on. 

3. Set up a virtual data room to share information

Virtual data rooms are highly secure online environments for sharing, managing access to, redacting documents and undertaking Q&A. Unlike other file-sharing solutions, virtual data rooms are purpose-built for high-stakes deals like M&A transactions.

Despite their power and scale, a good virtual data room can be set up very quickly without any specialist knowledge. When sellers use a purpose-built virtual data room, sharing documents can be as simple as setting the right reading permissions for authorized users; they couldn't be simpler to use for the buyer and seller.

The document security and role settings in Ansarada Data Rooms make it easy to grant the right people access to documents individually or at the folder level. When access is no longer permitted, you simply revoke permissions inside the data room and out of it.

Learn more: how to set up a virtual data room.

4. Initial opportunity and risk review

Starting with a rapid review to identify any red flags, risks and key opportunities can ultimately reduce costs and streamline the deal. This might be limited to hard due diligence — the facts, figures and metrics that define the health of the business. 

This review will identify where the buyer wants to learn more about the target company and the particular focus that each type of due diligence will take. 

5. Detailed review

The detailed review is where potential buyers scrutinize the target company’s data. The goal of this step is to learn everything possible about the business to later develop a valuation and inform negotiations. 

The buyer will look to understand how the company operates, its financial health, and sustainability, and whether it meets regulations and standards, including environmental standards. 

Bidders will begin building a comprehensive list of questions for the Q&A component of the due diligence process.

This step in due diligence can be time-consuming. Target companies can maximize their chances of a high valuation and deal completion by ensuring all documentation is well-organised, easy to navigate and clear. 

6. Due diligence Q&A

Once the document review is complete, the seller and bidder begin Q&A. This is the most intense stage of the due diligence process. As much as 70% of deal time can be spent on Q&A.

Bidders will ask questions to the seller who then directs the question to the right team member to draft an answer. Once approved, the answer is provided to the relevant bidder.

With multiple bidders and thousands of documents that questions can be about, Q&A can be a complex and time-consuming process without clear roles and workflows.

Centralizing the due diligence Q&A process within the virtual data room makes sense. This places it in the same environment as the corresponding documents,  making it easier to assign, track and follow up questions. This is especially true when you have multiple bidders asking questions.

7. Due diligence reporting and compliance

A due diligence report presents the information learned about the target company. This is used to make an assessment of the value of the merger or acquisition, potential risks and any ongoing compliance that needs to be undertaken. 

From a thorough financial audit to business model analysis, operations review and soft due diligence that considers company culture and readiness for change, the final due diligence report is comprehensive. This report can then be used to formulate an offer, negotiate terms and manage risks moving forward. 

How to avoid common pitfalls in the due diligence process

The due diligence process defines how the deal will proceed, so knowing what to avoid and what to do to nail it will ensure a smooth transaction. Here are some common pitfalls, with insights on how to avoid each. 

Inadequate preparation

Buyers and sellers may each be inadequately prepared. If M&A is part of a company’s exit strategy, the business should always be ready for due diligence. This means ensuring all key information is tracked, reported and kept in a clear, ready-to-use format. 

Buyers can prepare for due diligence by thoroughly researching potential targets and defining the goals of the merger or acquisition. The better the buyer understands the target company, the more likely it is to ask pertinent questions and look for the right information to inform the valuation and negotiations. 

The buyer should also have an efficient due diligence process that aligns with its goals. Skipping the preliminary assessment or rapid review stage can waste time (and money). 

Financial due diligence may be lacking

Financial analysis is critical in M&A due diligence. Having an experienced team and using a financial due diligence checklist can ensure that critical documents are not overlooked, data is not misinterpreted, or an inadequate analysis results in overvaluation or unforeseen risk. 

Target companies can prepare for financial due diligence by organising information and ensuring data is accurate and well-presented.

Legal and compliance risks not identified

Missing potential liabilities, overlooking regulatory or compliance matters or failing to review contracts can expose a buyer to legal risk following the deal. 

Shallow operational and cultural analysis

The post-merger integration process is critical in realising the maximum value of a deal. This process can be hampered by a failure to assess operational risks and opportunities, underestimating the role of cultural fit in successful integration or overlooking the market conditions and competition. 

Rushed due diligence processes

Due diligence is time-consuming but essential. Relying on third-party reports without independent verification, failing to ask the right experts, conducting due diligence without complete documentation or rushing information gathering can result in decisions based on incomplete or unverified data. 

Inadequate risk assessment

Buyers and sellers need to be aware of the risks and warning signs ahead of an agreement. Researching the parties involved and asking the right questions using a proper, traceable process can protect both sides from exposure to excessive risk.

The key to avoiding the common pitfalls of due diligence is adequate preparation. That’s why Ansarada has created the most comprehensive due diligence checklist available (free) for M&A.  

Ansarada's Data Rooms are purpose-built to run the due diligence process from start to finish as securely, quickly and effectively as possible to maximize your outcomes (make sure you get the highest purchase price) and minimize your risks.

How to conduct due diligence on a private company

Acquiring private companies can be lucrative and rewarding, but there are unique challenges to due diligence and preparation as there can be less public information available. Investors or potential buyers must form a relationship with the company to learn more about its business, people and profitability. It’s also unlikely that a hostile takeover of a private company will be possible. 

Before pursuing a privately-held target for M&A, both sides should check they have the resources to complete the transaction. Once due diligence begins, checking compliance, finances, human resources and the overall business strategy is the first rapid due diligence phase, followed by a deeper dive to accurately value the business and identify those risks and opportunities that will be material. 

Valuing a private company may be trickier, without liquidity and the public market caps to fall back on. It is also necessary to consider the management and leadership of a private and potentially smaller business to identify how the combined company will thrive after the deal. The personalities, culture and sentiment within the company will directly influence the post-deal integration. 

Some key things to consider in a private company are: 

• Tax returns, financial statements and annual reports
• Understand how capital is structured
• Contracts and liabilities, including employment
• Investments or marketable securities
• Details of all loans and credit
• Any key person risk

The best advice we can give buyers for undertaking due diligence on a private company is to know exactly what to look for. Using a due diligence checklist will ensure no stone goes unturned. You will be able to spot gaps in compliance and process easily, giving you greater confidence in your investment or purchase.

How long is the due diligence process?

Due diligence for M&A typically lasts for 30 to 60 days, extending to 90 days for complex transactions. Hitting this timeline requires an expert team and an efficient, traceable workflow so you can see exactly where the due diligence process has progressed at any given moment. 

While due diligence aims to be thorough and present a transparent overview of the target company, it is inevitable that learnings will continue after integration. Using a deal workflow that anticipates the post-merger integration sets you up for success during and after the deal.

Due diligence examples

Due diligence occurs wherever there are mergers and acquisitions. It can cross borders and jurisdictions, and involve global markets and myriad compliance standards. These are just a few examples of due diligence for M&A: 

• A global pharmaceutical company plans to acquire an Australian health tech company. The due diligence process would include reviewing intellectual property and patents, approvals by medical bodies, lab certifications, compliance requirements in the destination markets and scalability of the products and services. 
• A national marketing agency plans to acquire a small digital marketing agency. Due diligence will include reviewing intellectual property, assessing the client database and active clients, ensuring cultural fit, reviewing employment agreements and assessing processes and technology. 
• A mortgage broking firm plans to merge with an asset finance business. Due diligence will consider the aggregator used, compliance with all regulation, licensing, the total addressable market and synergies of the combined businesses.

Streamline due diligence processes with AI

AI is transforming mergers and acquisitions, in particular the due diligence process. By automating tasks like sorting documents, redaction, document translation, document review and risk assessment, AI due diligence enables more efficient due diligence and more effective use of resources as the due diligence team focuses on analysis and risk identification. 

With AI taking care of the mundane tasks the cost of due diligence drops and the value creation begins. 

Ansarada’s AI tools can analyze the real-time flow of data from interactions between bidding parties in a deal, including huge volumes of information. This enables dealmakers to garner value from tens of thousands of data points in seconds.

Imagine how fast this could make your due diligence process. With Ansarada, you can analyze a business's financial performance in minutes instead of days.

Due diligence process questions

What are the phases in the due diligence process?

The first phase in due diligence is a rapid review of the target company to check for any ‘red flags’ or deal breakers. The second phase is thorough due diligence. This analyzes financial data, operational processes and systems, HR, legal matters and other areas relevant to the type of company and the deal or investment. 

What is an example of a due diligence process?

An example of a due diligence process is requesting documents for financial due diligence to verify business numbers shared by a target company. Thorough financial due diligence processes first check for any red flags or risks, then proceed to validate the opportunity the merger, acquisition or investment presents. 

What is a due diligence checklist?

A due diligence checklist is a tool to guide buyers and consultants through the due diligence process to ensure nothing is missed that could be material to the deal or investment. It will include Board minutes, financial projections, contracts, intellectual property, assets and liabilities and cash flow.