Due diligence is the comprehensive investigation or appraisal audit that a reasonable business or person is expected to undertake before entering into an agreement or contract with another party. The audit of the potential investment refers to the research done before entering into an merger agreement and will confirm all facts such as assets and liabilities and evaluate its commercial potential. This act is heavily related to the fiduciary duty of the board of directors.
Performing this type of investigation contributes significantly to informed decision making by enhancing the amount and quality of information available to decision makers. This is turn reduces the number of failed mergers and acquisitions.
What Steps Are Involved in Due Diligence?
The list (without the full descriptions) is reproduced below. Of particular interest to merger arbitrage traders is point 9, “Antitrust and Regulatory Issues“, which is given in its entirety.Of course, in certain M&A transactions such as “mergers of equals” and transactions in which the transaction consideration includes a significant amount of the stock of the buyer, or such stock comprises a significant portion of the overall consideration, the target company may want to engage in “reverse diligence” that in certain cases can be as broad in scope as the primary diligence conducted by the buyer. Many or all of the activities and issues described below will, in such circumstances, apply to both sides of the transaction.
- 1. Financial Matters
- 2. Technology/Intellectual Property
- 3. Customers/Sales
- 4. Strategic Fit with Buyer
- 5. Material Contracts
- 6. Employee/Management Issues
- 7. Litigation. An overview of any litigation (pending, threatened, or settled), arbitration, or regulatory proceedings involving the target company is typically undertaken
- 8. Tax Matters
- 9. Antitrust and Regulatory Issues
- If the buyer is a competitor of the target company, understanding and working around any limitations imposed by the company on the scope or timing of diligence disclosures Analyzing scope of any antitrust issues
- If the company is in a regulated industry that requires approval of an acquisition from a regulator, understanding the issues involved in pursuing and obtaining approval
- Confirming if the company has been involved in prior antitrust or regulatory inquiries or investigations
- Addressing issues that may be involved in preparing a Hart-Scott-Rodino filing (if thresholds are met) and effectively responding to any “second request” from the Department of Justice or Federal Trade Commission
- Considering Exon-Florio issues if the transaction involves national security or foreign investment issues
- Other Department of Commerce filings if the buyer is a foreign entity
- Understanding how consolidation trends in the company’s industry might impact the likelihood and speed of antitrust or regulatory approval
- 10. Insurance
- 11. General Corporate Matters
- 12. Environmental Issues
- 13. Related Party Transactions
- 14. Governmental Regulations, Filings, and Compliance with Laws
- 15. Property
- 16. Production-Related Matters
- 17. Marketing Arrangements
- 18. Competitive Landscape
- 19. Online Data Room
- 20. Disclosure Schedule
Further Reading
- Small Business Kit For Dummies by Richard D. Harroch covers all the basics on, Recent tax law changes, Balancing your finances, Hiring and keeping employees, Effective management strategies, Accounting fundamentals
