M&A stands for mergers and acquisitions. This term is used to describe the process and phenomenon whereby a company is consolidated with another company.
The process of mergers and acquisitions can occur in different patterns. One such pattern is when two or more companies decide to combine their assets, structures and operations and exist as a single company. This approach is referred to as a merger. Usually, the companies involved are similar in size and operation.
Another pattern is known as acquisitions. In this form of operation, a company purchases the majority of the stocks of another company. It also refers to when a company outright buys out another company.
Sometimes, instead of being merged or acquired, two or more companies can decide to collapse their existing structures and fully integrate their operations. This pattern is known as “consolidation.” When this is done, an entirely new company is launched.
An M&A transaction is a very sensitive business transaction. As such, great care must be taken to ensure that it is done properly. A process that aids this is known as due diligence.
What Is Due Diligence?
When an M&A negotiation occurs, the company's representatives making the offer send the target company a letter of intent. If accepted, they will then request certain information about the target company. This information includes balance sheets, corporate records, and potential liabilities. These help them properly analyze the benefits and potential risks of acquiring that company. It also guides their valuation of the company and influences the offer they eventually make. This information is generally kept confidential and secured under a special digital asset repository called a "Digital Data Room".
M&A due diligence is the process by which an investigation or audit is carried out to confirm the veracity of the information provided about a company. It is performed by companies involved in an M&A transaction.
During mergers and acquisitions deals, the acquirer investigates the financial records of the target company and performs a risk assessment. Assets and liabilities are taken into consideration here, as well as accounting inconsistencies and other potential red flags. It also makes predictions regarding the company’s potential for growth. From these, an informed decision can be made.
Types of due diligence include:
- Financial due diligence
- Legal due diligence
- IT due diligence
The Purpose of Due Diligence
Performing due diligence has come to be regarded as a logical and vital process during mergers and acquisitions transactions. There are several reasons for this. Some of them include:
Verification of Facts
The first step a company takes after deciding to acquire another company is to initiate contact with the target company and request information about the company. It is based on this information that a decision will be reached concerning moving forward with the deal or not.
However, committing to a deal is not a trivial thing. Doing that without double-checking the information received is dangerous. Due diligence is a practice that helps verify the facts and figures supplied. This enables the acquiring party to make informed choices.
Discovery of Red Flags
Sometimes, the information supplied by the target company might be superficial or glossed over. If the company making the acquisitions does not employ due diligence, it can end up with a redundant investment on its hands.
A thorough investigation of the facts and figures presented can reveal the presence of liabilities, issues in operations or self-destructive policies. These elements are known as “red flags”. When they are discovered, the acquiring company can decide to either tackle the challenges or back away from the deal. However, without a due diligence report, the company can walk itself into a crisis and not know it.
Resolution of Valuation Disputes
The issue of valuation is the source of the majority of the disputes that occur during negotiations. M&A transactions are no different. The representatives of the company being acquired desire to get as much value from the transaction as possible. However, those from the acquiring company do their best to get the deal done for as little as possible. As such, their valuations on the purchase price will be different, which will lead to conflict.
However, if due diligence is employed, a fair assessment of the company can be made. The valuation obtained through due diligence is quite easy to accept and resolves prior disputes.
Performing due diligence can be cost-intensive and time-consuming. However, the value it brings to an M&A process is worth the price many times over.
IT M&A Due Diligence
When it comes to due diligence, there are several factors to consider. These factors stem from the various aspects of the business. The emphasis placed on them is derived from their level of importance to the company’s operations.
One such area is information technology, popularly known as IT. IT is the use of computer (and similar devices) hardware and software to create, store, modify, secure and share data. IT plays a very significant role in society today, as well as in our industries and economy. The world is becoming more digitized as each day goes by. More and more operations are becoming automated. Data is no longer stored on paper but in the cloud. IT has become very integral to our business operations and as such, should never be ignored.
This highlights the importance of performing IT due diligence during M&A operations. IT M&A due diligence is an assessment done on the IT system of a company. Through this process, a thorough analysis is done of the effectiveness, security, accessibility and drawbacks of the IT network. This is done to enable the buying company to know the capabilities of the IT system. It assesses whether it can succeed, be integrated into their existing system or should be discarded. M&A IT due diligence is a major factor in determining the profitability of the M&A deal after its conclusion.
Benefits of M&A IT Due Diligence
M&A Success Rate Improvement
IT due diligence improves the success rate of most M&A transactions because IT is a major indicator of integration success. The potential buyers need to be confident that the IT framework of the company they are acquiring or merging with is fully functional. They also need assurances that the technological system can be integrated with theirs at little or no additional cost. When this is confirmed through IT due diligence, they become more confident in the deal. As a result, they end up pushing for a positive conclusion to negotiations.
Data Security Enhancement
In this day and age, data is the lifeblood of every company. Millions are spent every year to improve cyber security and protect their data from attack. Through IT due diligence, the acquiring party can analyze how secure the IT system of the company to be acquired is. If any lapses are discovered, the company can decide whether or not to go along with the deal. This depends on the severity of the defect. If the company decides to go ahead with the deal, it is easier for them to remedy them or make contingency plans at this point. They can also decide to back out of the deal if the issues are too profound. This goes a long way toward ensuring that the buying party has a secure network moving forward.
Increase in Valuation
It has been discovered that IT due diligence can increase the worth of a company by up to 30%. This is because when M&A IT due diligence is performed, it highlights the intricacies and effectiveness of the IT system of the target company. This, in turn, aids in convincing the buyer to seal the business deal. It also increases the valuation of the business and the negotiating power of the seller.
Smooth Integration Promotion
IT systems make it easier for two or more companies in an M&A transaction to form a merger. They break down the barriers of time and distance and enable efficient management of operations. An M&A IT due diligence procedure will be able to examine the IT system in operation. This will enable the acquiring party to create roadmaps on how to successfully form synergies between both companies’ operations.
M&A IT Due Diligence Checklist
This checklist is used to take note of the various aspects of the M&A IT due diligence process that need to be taken note of. These include:
While conducting IT due diligence, it is important to take an inventory of the IT hardware in the selling company’s possession. This includes computers, cables, printers, desk phones, and many more. It is essential to take note of specific details, such as the cost, manufacturer, model number, lifespan, and working condition.
This aspect considers how secure the company’s IT network is. Under this aspect, ensure you run advanced tests on the firewall, review the security certifications and perform vulnerability checks on the system. It is also important that you run background checks on each staff member and review the company’s security and data management policies.
This aspect of the M&A IT due diligence checklist analyzes the human resources working in the IT department of the company being acquired. It involves taking note of the size of the personnel and the roles they have been assigned. It also involves assessing the level of skill of each staff member and discovering the amount that they are earning.
IT systems run on software. You have not done proper IT due diligence if you haven’t analyzed the software and applications used to run the various operations of the company. They include antivirus software, data management software, payroll software, and customer relationship software. You take note of their vendors, subscription status, and expiration dates (if any).
Goods and Services
In this aspect of the checklist, you analyze what the company being acquired does. What goods do they produce? What services do they provide? Do they deliver these services over the internet or any other virtual channel? Is there any part of the production or delivery that is IT-enabled? These are the things you must consider.
Internet Protocol System
While conducting M&A IT due diligence, ensure that you take cognizance of the company’s internet protocol system. Take note of the internet service providers and their average internet speed. Discover how each computer communicates with the others; having a diagram of the computer network will prove beneficial.
There’s no point in having a business if there are no customers to patronize it. So, analyzing the selling company’s relationship with its customers is very important. Take note of how the company communicates with its customers and how frequently it does so. Find out how long it takes for a customer to reach support staff, the frequency of complaints and how quickly customer complaints are addressed.
M&A IT Due Diligence Questions
Before M&A IT due diligence can be considered complete, and the deal successfully closed, certain questions must be answered. They include:
Questions About the Company
- Who owns the company?
- What are the company’s policies and bylaws?
- Is there a business plan?
- What metrics do we use to measure growth
- What is the leadership structure of the company?
- Are there previous Annual General Meeting reports?
Questions About the Customers
- What are the customers’ demographics?
- What is the current level of customer satisfaction?
- What have the customers been complaining about recently?
- How well are we retaining customers?
Questions About the Company’s Assets
- What are the company’s physical assets?
- Does the company own any machinery?
- Does the company have a warranty on any of its equipment?
- Does the company own any real estate?
- Does the company have any leases?
- Does the company own any intellectual property?
- Does the company earn from its intellectual property?
- How does this company manage and protect data?
- Does the company own any IT hardware assets?
- How much does each of the company’s hardware assets cost?
- Does the company own any IT software?
- Which of the IT software has licenses?
Questions About the Company’s Products and Services
- Which product does this company produce?
- What service does this company render?
- How well is it performing compared to its competitors?
- What are its strengths and weaknesses?
Questions About the Company’s Financial Performance
- How liquid is the company?
- How much does the company have as working capital?
- Where are the company’s financial statements for the last three years?
- Where are the company’s tax returns for the last three years?
- What is the company’s gross profit margin?
- What are the company’s recurring expenditures?
- What is the company’s debt portfolio?
Questions About the Company’s Legal Issues
- Does the company have any past or current litigation?
- Does the company need any license to begin operations?
- Does any regulatory body have jurisdiction over this transaction?
- Is there any legal risk associated with this merger?
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