Seven Key Areas for Acquisition Due Diligence in M&A
A growing number of mid-sized businesses today are merging with and acquiring other businesses in order to grow and expand. In fact, M&A activity set a record during the first half of this year, hitting $2.5 trillion. There is no doubt that merging with or acquiring another business can be an effective middle-market growth strategy. But there’s a tremendous amount of acquisition due diligence – the preparation and research – that must be done to help ensure a successful M&A transaction. This research is crucial to achieving the objectives you and your team have established for merging with or acquiring a target company.
Why Acquisition Due Diligence is Necessary
Performing acquisition due diligence is necessary to help ensure that you understand what obligations you’re assuming with the target company, the extent of the company’s contingent liabilities, intellectual property issues, legal and litigation risks and more. This is especially true in mergers and acquisitions involving private companies that aren’t subject to the same scrutiny pubic companies are – and where buyers have limited ability to obtain important information from public sources.
Acquisition due diligence should usually focus on the following areas:
Business financials — Acquisition due diligence starts with a thorough examination of the target company’s historical financial data. This includes financial statements (balance sheet, cash flow statement, and profit and loss statement) and key financial metrics, as well as an analysis of how reasonable the company’s financial projections are. Look especially closely at whether profit margins are growing or shrinking and how much working capital is required to maintain normal business operations.
Management team & employees — You need to find out about the quality of the target company’s management team and employees. Start by asking for a management org chart and detailed information about each manager’s professional background and experience. You also need to review any employment and consulting agreements; all employee incentive, bonus and compensation plans; and employment policies and manuals.
Technology & intellectual property — Find out if the target company owns any domestic or foreign patents and if they’ve taken adequate steps to protect their intellectual property. Also determine if the company owns any trademarks, service marks or copyrighted materials.
Customer base & sales volume — Determine who the target company’s top 10 or 20 customers are, how much sales revenue they generate and if there are high levels of customer concentration among them. Also determine how full the customer pipeline is and whether there is a risk of top customers defecting after the merger is complete.
Sales & marketing efforts — These will be crucial to ensuring adequate sales and revenue going forward. How is the target company’s sales force structured and compensated? How much money and resources does the company devote to marketing and sales promotions? And how effective have the company’s sales and marketing efforts been in the past?
Contracts & commitments — Reviewing all material contracts and commitments is one of the most important but also time-consuming tasks involved in acquisition due diligence. In particular, you should carefully examine customer and supplier contracts, equipment leases, employment and exclusivity agreements, property purchase and lease agreements, and powers of attorney.
Tax issues — Your acquisition due diligence related to taxes should focus on all tax returns (federal, state, local and foreign) filed by the target company over the past five years. Look for net operating losses and credit carryforwards, as well as any correspondence with tax authorities (such as the IRS) related to tax issues that may have arisen during this time.
Acquisition Due Diligence Challenges
As you can see, there will be a significant amount of information to pour through as you conduct acquisition due diligence. You will also need to make sure that the target company sends you a complete set of due diligence materials and that the materials they send you accurately reflect what’s going on in the company.
All of this can be overwhelming for many middle-market businesses that are embarking on a merger or acquisition, especially those doing so for the first time. One way to streamline and simplify the acquisition due diligence process is to bring in a project CFO from a CFO services firm to assist with your acquisition due diligence. This high-level financial professional will bring the expertise needed to assemble an appropriate acquisition due diligence list.
An on-demand CFO partner will possess the technical skill required to review the financial statements for potential issues. He or she will also understand the key deal parameters and thus be able to conduct the acquisition due diligence rapidly. As a result, the actual implementation of due diligence will be greatly simplified, and your business will realize many positive outcomes, including the following:
The acquisition due diligence process will be long enough to insure it’s completed properly, but short enough so it doesn’t affect the merger or acquisition.
You will be able to plan for the immediate integration of the acquisition into your organization.
The signed acquisition documents will not yield any unpleasant surprises down the road.
The acquisition will meet both your short-term and long-term business objectives.
Concluding Thoughts
A growing number of mid-sized businesses today are merging with and acquiring other businesses in order to grow and expand. There’s a tremendous amount of acquisition due diligence that must done to help ensure a successful M&A transaction. This research is crucial to achieving the objectives you and your managers have established for merging with a target company. An on-demand project CFO can assist with your acquisition due diligence, bringing deep expertise in creating an appropriate due diligence list and working with you to address prioritized tasks.
Mark S. Becker, Partner, CFO Edge, LLC
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