In this article, we look at:
- What are mergers and acquisitions (M&A) and how do they work?
- Why is due diligence important in M&A?
- How to perform due diligence in M&A?
Smart decisions and capable partners are vital in the corporate world, and a foundation of due diligence is essential for ensuring that the business continues to operate as securely and effectively as it can. This is especially true when considering major decisions such as merger and acquisition deals, where due diligence reports play a vital role in the safety and efficiency of the processes.
In this guide, we will look more closely at the process of due diligence in mergers and acquisitions, showing you how to properly scrutinise a company you intend to acquire and how to protect your assets and interests from potentially harmful mergers.
What are Mergers and Acquisitions and How Do They Work?
Mergers and acquisitions (often referred to as M&A) are two different processes used to increase a company’s reach and expand its potential. A merger is an agreement in which two companies consolidate their assets into one, before continuing under a single entity. For example SmithKline Beecham and Glaxo Wellcome, two of the biggest pharmaceutical companies in the UK, merged to form GlaxoSmithKline back in 2000.
An acquisition, on the other hand, is when one company purchases another, taking its assets (including stock, trademarks, and licences) in the process. In recent years, the business world has seen a number of major acquisitions from leading companies like Amazon and Apple, with the former acquiring MGM for its film empire, while the latter has taken over music-related companies such as Beats and Shazam.
Why is Due Diligence Important in M&As?
M&A deals involve the transfer of huge sums of money, and it is not uncommon to see deals worth billions on the news. A proper due diligence process is therefore essential to protect the financial interests of the businesses and their shareholders, and to ensure that the parties are aware of any risks that might be present.
Conducting due diligence could help:
Determine the value:
A due diligence report could provide some clarity on the entity’s assets and current financial position.
Find potential liabilities and risks:
If there are any serious regulatory or legal issues, such as repeated failures to follow AML regulations or media notoriety, due diligence could help identify them.
Understand the business better:
Conducting due diligence will help the interested party understand the inner workings of a business better, thus helping them make an informed decision about their purchase.
How to Perform Due Diligence in M&A
It is important to be thorough when performing due diligence prior to an M&A. The steps involved in this process can include:
Checking sanctions lists
Checking sanctions lists has always been a key part of the due diligence process, but it is even more important today, considering thousands of entities from multiple countries (including Russia, Iran, and North Korea) are under sanctions. If someone you are doing business with is on a sanction list, it could hinder the potential relationship and may even result in serious fines and penalties. For this reason, it is important to keep your lists updated and avoid issues that can result from using outdated sanction lists.
Ensuring regulations have been met
Regulatory agencies are trying to ensure that entities in the business world stay compliant to all relevant rules and standards, and would not hesitate to raise a concern with any company that fails to do that. For example, the rising threat of money laundering has led many financial regulators to adopt a strict, no-tolerance approach, and become more vigilant towards the smallest of transactions. Therefore, numerous companies in various sectors have fallen foul of anti-money laundering laws in recent years.
If the company you want to acquire is amongst them, you need to be informed, as it could suggest that there might be an inherent issue with its operations. It could even mean that it is under strict regulatory scrutiny, which could make the M&A process more difficult. Surprisingly, not many companies choose to be entirely transparent regarding their regulatory past and present, which is where due diligence steps in.
Looking for litigation
Has the company recently paid fines or battled through any significant legal cases? If so, what did those legal battles entail, why did they occur, and will they impact the way that you do business going forward?
Lawsuits are common in the world of business. The existence of a lawsuit does not automatically mean the deal is no longer viable, but it is certainly something that you would need to know about. Some of the most common legal issues seen as deal-breakers in the context of M&A deals revolve around criminal activities, but even cases regarding infringements on patents or personal rights could constitute a problem in the long run.
Class-action lawsuits filed by the current shareholders of a company are also worth inspecting, as they might unveil unforeseen or even surprising problems. Due to their nature, legal debates could sometimes have complicated contextual backgrounds or span over many years, which means that one must invest quite some time into deciphering them. Fortunately, litigation checks are amongst the cornerstones of professional due diligence, and a report will be sure to cover them.
Checking government connections
Government officials and politically exposed persons (PEPs) are often the ones on the receiving end of sanctions. They may also face stricter regulations than the average citizen. If the company you are doing business with has been involved with any government officials, this might complicate the M&A process. Checking the trading history and looking for any kind of government official ownership is always advised, and the relatives of PEPs people are sometimes on the radar of due diligence researchers as well.
Governmental institutions as a whole could also own shares in companies – whether they are privately-owned or listed on the stock exchange. Therefore, investing time into learning th e full background of an entity is even more important from a business perspective, as a potential government connection could not only be a financially risky endeavor, but could also serve as a triggering factor for some regulators.
Make sure you know who owns the company and what that ownership structure looks like. Whether you are buying them out or merging with them, it is key to know who they are, what role they play, and how that position will change going forward. You should also do your research on key individuals within the company, learning whether they have had any issues with regulators or local authorities.
Searching for negative media
It only takes one misjudged marketing campaign or social media post to bring a storm of bad publicity down on someone. It is rare for a company to be truly “cancelled”, but bad publicity can still have a massive impact on an entity’s revenue and should be discovered and considered beforehand. Social media can provide most of the answers, along with review sites and discussion boards.
But negative media is much more than a simple scroll down the socials, especially in the presence of authoritative traditional media outlets. Sometimes even companies with pristine financials have their secrets to hide, and investigative journalists are always on the lookout for inconsistencies in the story. Their articles and publications are used by risk intelligence researchers as the basis for even broader investigation. And due diligence could go even a step further than that, transcending language barriers by covering negative stories from all over the world, thus minimising the chances that information remains hidden somewhere.
We can help: Due Diligence for Mergers and Acquisitions
There are numerous complicated M&A steps, which is why they can drag on for many months. But it is imperative to follow each one of these steps meticulously, and that is especially true for due diligence. For more information on key due diligence procedures, take a look at our guide to PEP risk categorisation.
If you want some professional assistance to ensure this process runs smoothly, get in touch with A Data Pro. We provide extensive due diligence reports, sanction lists, and more, keeping your company compliant and safe every step of the way.