Financial due diligence plays a crucial role in keeping a check on the financial health of an organization. The due diligence process helps to identify any existing anomalies in the financial data. Although financial due diligence is required regularly, it becomes vital in the case of mergers Acquisition (MA) transactions. Merger and acquisition transactions can be explained as financial transactions that encompass ownership of companies or consolidation with different legal entities.
Simply put, it is a process in which organizations own or join hands with other businesses for mutual gains. Many a time, when big organizations have to enter a certain industry, they simply acquire an existing business after meticulously assessing its financial performance.
Objectives of a due diligence process
Due diligence can be explained as a process of investigation that helps to identify any existing discrepancies and challenges related to a particular entity. By gathering important insights into a business, people can make more informed decisions. Some of the most important objectives of a due diligence process are stated below.
- Establish compliance with applicable laws and regulations
- The revelation of regulatory limitations on transactions proposed for businesses
- To evaluate the value of intangible and tangible assets including plants and equipment
- To figure out a viable purchase amount and transaction method
- Verifying important details required to draft a merger or acquisition agreement
- To assess any potential anti-trust issues that might forbid the proposed MA deal
- To identifying deal-breaker assets or liabilities, usually those with high economic impact
- To figure out any legal or financial risks associate with a given transaction
The role of due diligence in MA deals
Merger and acquisition transactions are always of high economic value and involve a lot of capital. Companies acquiring other businesses need to check their financial health to assess the feasibility of the transaction. They need to have an estimate of the targeted company’s worth for negotiating the deals and finding a good bargain. On the other end, companies being acquired need to obtain a fair value for selling their assets to the other company. This also requires conducting financial due diligence and addressing any discrepancies.
Due diligence can be carried out by either the investors or the target firm itself. Both parties have different objectives to conduct due diligence. However, it is beneficial for both parties to conduct the required due diligence before participating in an MA deal. The main aim of the due diligence report is to establish a fair market value for the company and identify any financial abnormalities. From an investor’s point of view, a due diligence report provides a detailed insight into the financial health of a company.
Due diligence service providers leverage a wide range of analytical and investigative methods to evaluate the financial health of a company that is seeking investments or wants to enter into a partnership deal. The financial professionals who conduct the due diligence operations also identify and assess the factors that contribute to a business’s overall profitability. They rely on the historical data and past performances of the company to figure out its profitability. They also use analytics techniques to project future growth prospects.
Types of due diligence involved in an MA deal
MA deals usually involve a large sum of money that is paid or obtained during the transaction. This requires various types of due diligence needed to conduct a thorough investigation. Here are some important types of due diligence involved during MAs.
- Business due diligence
This due diligence focuses on the profitability and growth aspects of a business. It helps to verify if a company’s revenue and cash flow are sustainable from a long-term investment point of view.
- Legal due diligence
Legal risks can incur huge financial losses. Legal due diligence is required to identify any suspicious activities being performed within an organization.
- Accounting due diligence
The primary objective of conducting accounting due diligence is to verify the accuracy of the financial data provided.
- Financial due diligence
The financial due diligence involves researching the target companies and assessing their financial records to check if it’s feasible to acquire or merge with a particular company.
Conclusion
The due diligence process plays a crucial role during MA transactions. It helps to identify any existing anomalies that might impact the growth prospects of a business.
