Due diligence is a very important process in Mergers & Acquisitions (M&A). M&A is when one company buys another or joins with it. Before this happens, the company that wants to buy needs to check the other company very carefully. They do this to make sure they have all the right information.
The main goal of this check is to find and reduce risks. It also helps them find new chances for growth. They look for any hidden problems and use this information to make smart decisions for the future.
Two Main Types of Due Diligence
Due diligence looks at everything about a company. There are two main parts:
1. Hard Due Diligence
This part looks at numbers and facts. It uses financial reports and other official documents. This is where lawyers, accountants, and negotiators do a lot of work.
Money Check: They check the company’s financial reports. They look for mistakes and make sure the company is financially stable. They check things like cash flow and how much money the company spends.
Assets and Debts: They study the company’s assets (what it owns) and liabilities (what it owes).
Property and Ideas: They check the value and risks of things like patents, inventions (Intellectual Property), and physical buildings or machines. This is very important for technology or manufacturing companies.
Taxes: They look at the company’s tax situation to find any potential tax problems or ways to save money on taxes.
Future Plans: They check the company’s plans for future performance and study the market to see if it can grow.
Laws and Rules: They make sure the company follows all laws and rules. This includes looking at employee contracts, legal disputes, and rules about bribery and safety.
2. Soft Due Diligence
This part is about the human side of the business. It’s about things you can't measure with numbers. This is very important because many M&A deals fail when companies ignore the human element.
Company Culture and Management: They look at the quality of the company leaders and how employees work together. A key part of this is seeing if the employees of the two companies will get along well after the sale.
Employee Motivation: They check how employees are paid and what encourages them to work hard. This helps them guess if the deal will be successful.
Customers and Suppliers: They check how loyal the customers are and how they might feel after the company is sold. They also look at reviews and other data about customers and suppliers.
HR Due Diligence: This is about looking at the company's people, how they are paid, and the overall company culture.
Other Types of Due Diligence
Besides the hard and soft checks, there are other special types:
Commercial: They look at the company’s place in the market and its chances for future growth.
Technology (IT): They check the company’s computer systems and cybersecurity. They look for risks, security issues, and how easy it will be to combine systems.
ESG: They check how a company acts on environmental, social, and government issues. This includes things like how they treat employees and their impact on the environment.
Red Flags and Problems
A company doing due diligence must be careful and look for red flags, which are signs of problems.
Missing Papers: Some documents, like financial reports or contracts, might be missing or not complete.
Confusing Ownership: The company’s legal structure might be unclear and hide problems.
Legal Issues: There might be ongoing lawsuits or old legal problems that were not fixed.
Unhappy Employees: High employee turnover or low morale can be a sign of leadership or culture problems.
Weak Cybersecurity: A lack of security rules or old computer systems can be a big risk.
The Role of the Board
The board of directors is a group of people who lead the company. They are responsible for making sure the due diligence process is done correctly.
Leadership: They set the rules for what risks are okay and make sure the purchase fits the company's main goals.
Review: The board checks all the due diligence findings before they make a final decision. They make sure to follow up on all the important points.
By doing a careful and complete due diligence, companies can have much more successful M&A deals. They can go beyond just looking at numbers and also think about the company's culture and long-term risks.
