What Is Due Diligence And Why Is It Important?
Mergers and acquisitions can be an exciting part of business transformations, especially if you’re a business owner who's received an attractive offer from a prospective buyer. Due diligence, simply put, is essentially an investigation to target any risk from a legal perspective. It should be conducted prior to entering into any agreement or transaction, because although we’d like to believe that Uncle Charlie is giving us a good deal on that farm you’ve been visiting since you were a child, Uncle Charlie may have been waiting for the opportunity to sell off his mismanaged, broken and beaten-down farm to an unsuspecting victim. It further serves as a mechanism to ensure that information is recorded the way it is presented.
Amongst growing labour and financial concerns, commercial enterprises are also faced with the added exertion of ensuring that they perform the necessary due diligence in respect of their transactions and the establishment of business relations. While the future is, no doubt, filled with promise, it's important not to get too ahead of yourself, as the next step in the process can turn out to be a lengthy one - due diligence.
What is Due Diligence?
Due diligence is an important part of any acquisition process and represents the orderly investigation of any matter pertaining to business dealings. Since no two companies are the same, it's important that a diligent effort is made to obtain any information that would be relevant or necessary in the sale or purchase of an organisation and its assets. Due diligence helps clients to recognise any financial, legal, or operational risks that may not be noticeable from an outside perspective.
Why should you perform Due Diligence?
While due diligence may seem like it only benefits one party, the fact is that due diligence helps both the buyer and the seller in a business acquisition.
From a buyer's perspective, due diligence gives them peace of mind that they're making the right deal and have all the relevant information that they require in order to make a good purchasing decision. This information can include learning more about the company's existing customers and partner relationships and either validates positive assumptions or alerts them about potential irregularities.
From a seller's perspective, due diligence helps a business owner take a deeper dive into the financial integrity of their business and can also help them uncover the fair market value of their company. As valuations and acquisition prices are only getting higher for many business sectors, it's essential that companies invest in quality due diligence reporting and services.
It further allows for the proper understanding of the markets that an entity chooses to do business in and allows a company to assess its operational requirements in respect of potential risks.
What is Usually Included in a Due Diligence Report?
Due diligence reporting can be broken down into five main categories:
Environmental Considerations
For some businesses, there may be certain environmental risks associated with business operations. In this case, time should be taken to review such potential risks and how they affect the company currently, and in the future.
Legal Reviews
The main question here is whether the business being acquired has any liabilities, which is an important consideration in due diligence. Depending on the size of the organisation, legal teams may need to look into current partnerships and contracts in place to ensure that there are no irregularities before moving forward.
Financial Information
Most companies spend most of their due diligence looking at and confirming financial reporting. All documentation and accounting information should be up to date and should also accurately show the numbers that were disclosed during the deal-making process.
Business Sustainability
Cash flow management and long-term business sustainability are important aspects to consider. Careful analysis and previous years of sales data should help potential buyers in picking up trends and deciding whether their investment is worthwhile.
IT Capabilities
Identifying your company's current security risks or any other IT problems is another way that investors assess your company's value. Depending on the industry your business represents, this may be another major factor when evaluating your business.
Due diligence will always be an important part of mergers and acquisitions, especially as a deal comes to a close. It goes a long way in ensuring the efficient running and avoidance of unnecessary disputes and red-tape in respect of businesses and although it does not function as a catch-all, it does allow for the mitigation of significant potential risk.
Contact an expert at Metric Investments for any of your valuation or due diligence needs.
