What is merger and acquisition due diligence?

Due diligence is a vital activity in M&A transactions and conducting M&A due diligence in today’s global marketplace is a demanding, high-pressure undertaking that requires considerable skill and expertise.

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What is due diligence?

“Due diligence" first came into use as a result of the passage of the U.S. Securities Act of 1933 which transferred responsibility onto securities dealers and brokers to fully disclose to potential investors any material information related to the securities or instruments that they were selling. The consequence for failing to disclose such information made them liable for criminal prosecution. However, the authors of the Act understood that making full disclosure a legal requirement left the securities dealers and brokers vulnerable to unfair prosecution if they failed to disclose some material fact that they did not have, or could not have reasonably had, prior knowledge. So, to provide protection to the dealers and brokers, the Act included a legal defense which they called the “due diligence” defense.

Essentially, the due diligence defense meant that as long as the dealers and brokers exercised due diligence in their investigation into companies whose equities they were selling, and fully disclosed to the investor what they found, they would not be held liable for information that was not discovered in the process of that investigation.

The evolution of due diligence

Since the passage of the Securities Act, the meaning of the term “due diligence” has become associated with the orderly investigation of a variety of matters pertaining to business and has been adapted for use in many situations. Regardless of how it is used, “due diligence” implies that the person conducting the investigation has made a “diligent” effort to obtain all of the relevant and meaningful information pertaining to the matter under investigation and has disclosed all of that information in a dutiful and forthcoming manner. In other words, thorough, conscientious due diligence continues to provide a defense to those who find themselves tasked with the investigation of an important business matter.

Merger and acquisition (M&A) due diligence

Due diligence is a vital activity in M&A transactions, and may consume several months of intense analysis if the target firm is a large business with a global presence. Using a variety of methods and accepted principles, the due diligence team pursues an answer to the question: “Do we buy–and if so–how do we structure the transaction and how much do we pay?” To answer this question, M&A due diligence activities typically focus on four areas at a target firm:

  •  Strategic Position
  •  Financial Data
  •  Operational Assets
  •  Legal Matters

Each of these four areas can be further sub-divided into business, legal, and functional areas–including IT–each receiving the appropriate level of attention and analysis based upon the category and nature of the deal.

Conducting M&A due diligence in today’s global marketplace is a demanding, high-pressure undertaking that requires considerable skill and expertise. As a result, firms that do a lot of M&A transactions often develop their own in-house M&A due diligence expertise, whereas firms that pursue occasional M&A transactions often engage outside professionals to assist them with this highly complex and risky activity.

In my next post I will describe the categories of M&A IT due diligence.

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