Due diligence - is it worth it? Due diligence is often seen as a tick-box exercise and can too easily be rushed in the flurry of activity to get a deal done, but it plays a significant role in the deal process.
Due diligence gives a buyer a realistic picture of how a business is performing now, as well as how it might perform in the future. It highlights any deal-breakers, issues or problems that might need to be covered in the legal representations and warranties. Financial due diligence is about checking the figures and ensuring that there are no black holes or hidden issues, and this usually commences when price and terms have been generally, but not contractually, agreed with the seller.
In any deal, an exclusivity period should be agreed to enable due diligence to take place. It is important to recognise that due diligence should add genuine value to the deal. It should not only ‘say it as it is’ now, but also identify areas of opportunity for the future, providing some level of comfort that the business in question is sufficiently well-resourced to take advantage of those opportunities. As much thought and preparation should go into the due diligence exercise as to any other aspect of the transaction, and sufficient time and resource must be made available for the work done to be meaningful. Otherwise the end result could be a bland and generally uninformative due diligence document that doesn’t add value.
Preparation is key
The key to a good due diligence exercise is preparation and involving the management team of the target. An information request should be sent to the management team at an early stage in the process and certainly before the due diligence team arrives onsite. Investor and management teams should work closely together throughout the exercise. It’s also critical that a draft report is shared, as early challenges, such as the questioning of recommendations and findings, will save time later. Importantly, sharing the draft will enable management to confirm the factual accuracy of the work done.
Does due diligence deliver in practice?
A study by Cass Business School in the UK and Intralinks Holdings of the impact of enhanced due diligence in public transactions, demonstrated that a longer due diligence process results in better deals for buyers. It showed that longer and more in-depth due diligence provides buyers with additional information on the target that can be used to negotiate a lower price, whereas deals with a shorter due diligence period have significantly higher takeover premiums paid by the buyers.
Sellers, on the other hand, appear to be disadvantaged by a longer due diligence period as their negotiating position weakens. Sellers may therefore aim to limit the amount of time allowed for due diligence. Professor Scott Moeller of Cass commented:
“Research indicates that those acquirers who take the time to conduct a longer due diligence, presumably to understand better whether the business case stacks up and the valuation is realistic, do benefit significantly. For sellers with high-quality assets, competition for those assets should ensure premium valuations. However, for those unfortunate deals with limited competitive interest, this research implies that acquirers can press their advantage to lengthen the due diligence period to attempt to discover information that can be used to lower the price paid.”
If this research is correct, then it is clear that negotiating the due diligence process is itself a key component of the overall deal negotiation, rather than just a piece of work that has to be done once everything else is agreed.
The Cass/Intralinks research related to public company transactions where due diligence is undertaken confidentially and before any offer is made. But the same principles apply in private transactions. Any company seeking to acquire a business should use due diligence to ensure as much as possible, the business is worth the price being paid.
For more information, contact:
Saffery Champness, UK
T +44 (0) 20 7841 4176