Importance of Due Diligence in M&A

What is Due Diligence

The goal of due diligence in the M&A process is for Buyer to confirm Seller’s financials, contracts, customers, and all other pertinent information. In other words, the goal is to make Buyer comfortable enough that he goes through with the deal and closes.

Important points to consider in Due Diligence

Part of any comprehensive diligence process is contract analysis - and usually is the most painful part as well. This requires the company being acquired to produce all their key documents. This includes any large sales deals, key employee agreements, IP rights, NDAs, large suppliers and more. Through this process the acquiring company is trying to determine a few things:

- Does this new company we are acquiring have an acceptable level of risk. This can mean different things to different companies, but first and foremost, the acquiring company wants to determine does the combined entity provide any issues for them.

- Are there change of control provisions in the major contracts of the company we are acquiring - this matters because often times partners can terminate your contracts or completely void them out if you have a change of control (which an acquisition would be considered). This is very important because the acquiring company doesn't want to lose all these new customers. But can also work the other way, where the acquiring company wants to be able to terminate some of your agreements if those contracts are with competitors or takes the company in a direction they don't want to go.

- Financial analysis / Synergies - When you acquire a company often times you can negotiate bulk discounts with your suppliers and hopefully reduce your cost. At the same time, you want to make sure you don't lose sales. Sometimes what can happen, is if both companies are doing business with one company, that one company will also want to negotiate bulk discounts. During this process, you want to determine what the resulting company looks like from a financial point of view to make sure this acquisition is additive and not detrimental.

- Intellectual Property - Are there certain contracts where you gave away IP, or ways that you may have licensed other people's IP to create your own. Based on how those contracts look, the company being acquired may not actually own all the IP the acquiring company is hoping to come away with.

- Employees - You want to make sure you can lock up the most important employees at the acquiring company, and also look at what the combined company looks like. Many founders may already have a good chunk of their equity vested, so instead of giving them a payday and allowing them to leave, you would be forced to sign them on for multiple years as part of this acquisition to make sure they stick around. You can make this part of the terms of the acquisition. Often times there are divisions of the company you are acquiring that you may not need to transfer over, and those employees then could be let go - usually with a generous package to thank them for getting the company to this big point.

Overall, there's a lot of work during the diligence phase of an acquisition, and it is very important to run through these contracts to truly figure out what you are working with on both sides. This requires good diligence as well as good contract management.