Thought Leadership  •  May 03, 2021

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Understanding the Financial Due Diligence Process and Its Importance

The financial due diligence process is critical to the success of a merger or acquisition, and there's a lot more to the phrase than you might think. Review the transaction details of M&A due diligence to make sure everything is on point to happen by the timetable of the deal.

Contractual Due Diligence in M&A

Due diligence in a merger or acquisition puts both parties at ease. It allows the buyer to confirm key facts about the seller — including the company valuation, client list, outstanding debts and obligations, and other parts of the business operation that will necessarily affect the merger. The due diligence team will often request intellectual property, litigation history, financial and insurance information, information on stockholders, and other corporate records.

What to Expect in Due Diligence

The first step in any due diligence process is to gather a key team of stakeholders who will perform the research. These teams usually include legal professionals, financial professionals, investors and core personnel. To help ensure completeness, the due diligence team will generally compile a checklist so that nothing important is overlooked.

Once the checklist is made, the process of due diligence is largely a matter of the buyer's side obtaining the necessary documentation from the sell side to verify that the business presented itself accurately.

Once the information is gathered, the buyer's side will usually review everything. It will pay special attention to anything that could potentially be  a red flag. If something is discovered in the due diligence phase that turns out to be a major problem, it could prevent the deal from continuing.

If the buyer's side has questions about any information obtained, the target company will be able to address those questions. The due diligence process may last several weeks up to several months and usually commences after the letter of intent is signed.

Sell Side Due Diligence

Much of the sell side due diligence focuses on making the company look as valuable as possible without exaggerating the truth.

The onus is on the seller to produce accurate and complete documentation, so the deal can proceed. Organization will go a long way toward streamlining the due diligence phase. Deal room software allows the seller to organize requested information, verify its completeness, communicate efficiently, and do whatever is required to prepare for a smooth deal.

Buy Side Due Diligence

Buy side due diligence requires a careful eye to understand the opportunities and liabilities moving into the deal. No merger is perfect, and frustrations can arise after the fact if the buyer feels like the target company wasn't "worth it" or the two company cultures can't be blended.

To set the deal up for success, the buy side should focus on the following:

  • Formulating clear goals going into the M&A: Having clear goals at the outset is the best way to stay focused on the long-term benefits throughout the due diligence process.
  • Auditing financial records: Once the buy side has a clear understanding of the numbers, it can make business decisions without leaning on emotions. The buy side should review financial statements, revenue, stock history, inventory, projections for growth, tax forms and the business valuation.
  • Inspecting documents: The buy side will spend a lot of time reviewing the documents provided by the sell side. The buy side will want to focus on business practices and any legal or financial considerations that could sway the deal. Lastly, the buy side should review the business plan for viability.
  • Risk management: A smart buy side will consider any perceived risks after the documentation review to understand next steps when the deal moved forward.
  • Final offer: Given that the due diligence may affect the cash offering, the buy side might present a final offer that correlates to the information obtained by the due diligence process.

How DFIN Can Help Your Processes for M&A Transactional Due Diligence

It is not unusual for the due diligence phase to last several weeks or several months, depending on the complexity of the business deal. However, there are ways to streamline the process of merger and acquisition due diligence.

Our contract analytics software uses artificial intelligence to reduce the amount of time it takes to comb through documentation. Clients can automate data extraction to home in on what matters most with confidence that nothing is being overlooked. Clients are typically able to shave the due diligence time in half, thanks to our core software.

The sell side will appreciate secure document sharing and the multimedia interface that turns due diligence into storytelling. When the details are ironed out, both sides will appreciate the automated contract review. All files are securely shared within the software and protected with some of the most secure architecture for ultimate peace of mind.

Mergers and acquisitions are complicated, but due diligence need not be. With technical solutions backed by 24/7 customer support in your local time zone, DFIN is a choice partner when it comes to M&A and related financial reporting considerations.