Guide to M&A

Due Diligence

www.midaxo.com
Contents

Overview 3

The Three Pillars of Due Diligence 4

The Deal Life Cycle 5

Scoping a Due Diligence Engagement 5

Asset Versus Share Transaction 9

Pricing the Engagement 10

Preparation 11

The Due Diligence Process 12

Due Diligence Etiquette — Key Considerations 13

Working with Virtual Data Rooms 14

How to Report Findings and Negotiate the Transaction 16

Common Due Diligence Mistakes 17

Key Terms 18

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 If you have decided to pursue an M&A strategy, and have identified a Target,
consideration must be given to Due Diligence — an in-depth fact-finding exercise
helping you to understand a Target in detail and establish whether the acquisition
makes Strategic, Commercial and Financial sense for your organisation.

Overview
Due diligence is a crucial stage in the deal life-cycle, During the due diligence process the Target is
where the Target makes available all financial, usually expected to disclose everything requested
legal and other information that is material for the by the acquirer — unless the acquirer is a close
acquirer’s evaluation of the Target and it’s value. competitor and the Target has a very strong
The process cannot be overlooked and can be position in negotiations.
viewed as an investigation into a Target prior to
Companies conducting a high level of M&A
acquisition, investment, refinancing, restructuring,
activity often develop their own in-house M&A
public listing (IPO) or similar transaction. The
due diligence expertise, while those pursuing
process may require many months of dedicated
occasional transactions usually engage external
time if the Target is large with a global presence.
advisors to assist them.
The purpose of due diligence is to increase the
A successful due diligence process should enable a
acquirer’s understanding of key information
potential acquirer to answer any question from three
supporting a transaction — for instance, what
conceptually distinctive areas — namely:
exactly is being purchased — therefore, facilitating
informed decisions while serving to identify and • Strategic Rationale for the transaction;
mitigate key risks pre-deal.
• Risks Reduction (which may result in “deal
Due diligence helps an acquirer to understand breakers”);
how the business of the Target is conducted • Post Diligence technicalities in order to close
and how it may be able to be integrated into the transaction successfully (see Figure 1).
an existing group of companies. In addition to
it revealing the information required to assess The due diligence process should provide
possible financial, legal, and regulatory issues, assurances that proceeding with the acquisition
the process provides valuable insight into a is the right decision and that the right price is
Target’s structure, culture, operations, human being paid for the Target, identify reasons for price
resources, supplier/customer relationships, negotiation, or provide suitable rationale for walking
competitive positioning and future outlook. away from the transaction.

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The Three Pillars of Due Diligence
Figure 1.

Strategic Rationale Risk Reduction Post Diligence

• Transaction Rationale • Financials • Revise Valuation

• Market Attractiveness • Tax • Assess Risk
• Competitive Position • Legal Issues • “Go/No Go”
• Value Creation • Human Resources • Transaction
Potential • Environment, Real Documentation – e.g.
• Integration Enablers Estate, and Insurances Disclosure Letter, SPA
(Protections > Warranties
• IT Operations
& Indemnities)

Standard outputs of the due diligence process may include:

• Information which may have a significant bearing on the decision to proceed with the transaction;
• Information upon which transaction terms may be based;
• Information which could be used in price negotiations;
• Factors affecting tax and financing structure;
• Risks for which protection in the form of warranties* and/or indemnities** may be necessary.

Due diligence usually takes place upon the signing of the Letter of Intent/LOI (or Heads of Agreement in the UK)
with an offer typically predicated on the basis of “subject to due diligence” – see Figure 2.

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The Deal Life Cycle
Figure 2.

1. Strategy 2. Target Identification

3. Confidentiality
Agreement (NDA)
10. Deal
Completion/Close

4. Valuation

The Deal Lifecycle

9. Contracts &
Share Purchase
Agreement 5. Letter of Intent
(LOI)

8. Negotiation

6. Due Diligence
7. Deal Structure

Scoping a Due Diligence Engagement

The first stage of a due diligence engagement should be to consider the scope of the work required. In doing
so, consideration must be given to the significance of the proposed transaction in the eyes of the acquirer, the
size of the Target relative to the acquirer and the degree of access to information expected to be granted by
the Target.

The company requiring due diligence of a Target should be mindful of (i) what benefits are expected to arise
from the due diligence process (ii) the areas of work to be covered by external advisors (if appointed) and (iii)
what areas the acquirer may cover themselves via access to in-house resources.

The company commissioning the due diligence should work with the Target to formulate a timetable (also
with their external advisors if appointed) to ensure a smooth due diligence process and timely delivery of
findings/the report (which will act as a meaningful decision-making tool).

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There is no prescribed format for what a due diligence engagement may encompass — rather, each engagement
will be bespoke and tailored to the specific transaction and needs of the user. However, there are some
fundamental practical issues to consider when scoping a due diligence engagement:

• Communication/misunderstanding due to language barriers and cultural issues if the transaction is

cross-border;

• Timezone differences and public holidays if the transaction is cross-border — particularly important
if either side is working to tight timeframes;

• Inexperience in the M&A process (Target, acquirer or external advisors) creating confusion and delays;

• A smaller Target should be encouraged to use professional advisors (M&A advisors and lawyers)
from the outset rather than trying to deal with the complexities of the M&A process alone;

• Limited access to the Target (particularly if competitors) may limit the scope of due diligence possible;

• For reasons of confidentiality a limited number of key individuals may be involved with the Target, therefore
causing delays;

• Scheduling/meeting deadlines may be difficult if several parties are to be involved in the due diligence
process (for instance — key management of the Target and any appointed external advisors — lawyers,
M&A advisors, consultants).

The scope of a due diligence engagement depends on the user’s assessment of their needs, the nature and
size of the Target and transaction and the perceived risks associated with the Target. The extent of due
diligence required may vary due to a number of factors.

The scope of due diligence may be less Conversely, the scope of due diligence may
extensive if: need to be increased for reasons such as:

• The Target is in a strong financial position • The Target is not strong financially (for instance
(for instance — creditworthy, strong cash — low credit rating, minimal cash reserves,
reserves, low level of debt, customer contracts significant debt, limited contracts in place giving
in place providing certainty over future revenue); uncertainty over future revenue);
• The Target is prepared to provide assurances • The Target is unwilling to provide extensive
to the acquirer in the form of representations, representations, warranties and indemnities;
warranties and indemnities (see p.18); • The transaction is a share purchase, merger or
• The transaction represents an asset purchase an asset purchase with a number of liabilities
(rather than share purchase) with liabilities not being taken on by the acquirer.
being taken on by the acquirer (see p.9).
Due diligence typically falls into the categories as
outlined below. To ensure comprehensive coverage
a detailed due diligence checklist can be used to
assist with the scoping process.

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Financial Due Diligence
Covering a review of historic financial results including the balance sheet, profit & loss and cash flows of the
Target (including any subsidiary companies to be acquired) with the possibility of particular attention being given
to significant projects/contracts, the quality of earnings (contracted and recurring or one-off in nature), how
realistic future financial projections are, the strength of the balance sheet (including the composition of assets
and liabilities) and the quality of management reporting;

Any tax issues arising — such as historic compliance with mandatory (corporate and social taxes) and any other
specific taxes.

It is notable that the scope of financial due diligence is dependent on the availability and quality of financial
information and how it is organised within the Target (for instance, smaller companies may not produce
monthly/quarterly management accounts).

Furthermore, in today’s economic climate particular focus should be given to any pension schemes and the
associated liability position, which in some instances, could exceed the total transaction value.

Commercial Due Diligence Operational Due Diligence

Commercial due diligence includes a review of Operational due diligence gives attention to
various commercial factors (including those outlined non-financial matters of a Target, which may
below) and should result in a detailed assessment encompass:
of the Target’s positioning within its sector.
• Review and appraisal of systems and
• Market structure, size and conditions specific processes (including IT systems and the
to the sector; internal controls environment);
• Sector specific legislation (including that which • Review of the key management team and
may be implemented in the future); senior staff;
• Key competitor analysis, market share and • Staffing levels and other HR matters;
positioning; • Insurances and risk assessment.
• Barriers to entry;
Operational due diligence highlights aspects of
• Customer and supplier feedback;
a transaction, which can foster improvements
• Health of customer relationships/customer in productivity and profitability for the acquirer.
satisfaction; Specifically, it can help in quantifying the cost and
• Credibility of the business plan; benefits of implementing efficiency improvements
• Business plan achievability and limiting factors. and the resultant impact on price.

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Legal Due Diligence Human Resources (HR)
Due Diligence
Legal due diligence is as important as financial and
commercial due diligence in ensuring the success of
a transaction.
The emphasis of due diligence into
areas of human resources should be on:
The process entails an investigation of any legal
risks associated with the rights and obligations of • Compliance with employment laws;
the Target. Areas covered under the scope of an • Employee contracts;
engagement typically include:
• Employment related liabilities (such as
• Asset and property ownership; redundancy payments and social taxes);
• Intellectual property (IP); • Other issues likely to be outlined in a due
• Loans; diligence checklist.

• Securities; Organisational, culture, and other people issues

• Employment; should ideally be investigated in face-to-face
• Corporate governance; meetings and interviews with key management and
other key members of staff within the Target so as
• Customer or supplier disputes and any
to provide an idea of cultural fit between the acquirer
pending litigation.
and the Target.

Consideration should also be given to post-deal

A number of fundamental areas should be matters and the integration plan from an HR
covered as part of the legal due diligence perspective in terms of retention of key talent,
process, including: communication and integration of company
cultures.
• Incorporation and existence of the Target;
A key priority (before the due diligence process
• Legal and ownership structure;
commences) is to determine whether the acquirer
• Existing contracts (for instance – customers, is required to file details of the potential acquisition
suppliers, management); with the relevant competition authorities and if so,
• Adherence to regulations (including a history of whether there is any risk of a potential negative
any breaches); ruling or any requirements for partial asset
• Insurances (including a review of any past claims). divestitures, for instance.

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Environmental Due Diligence
Environmental due diligence is an increasingly important part of the due diligence process.

Environmental liabilities can be substantial and difficult to uncover —

­ thus presenting the possibility for an
acquirer to be subject to unforeseen costs. Unrecorded liabilities relating to land or water contamination, for
instance, can cost an acquirer significant amounts, which can be disproportionate to the overall transaction
size in a worst-case scenario.

While there is a downside in failing to consider environmental factors during the due diligence process, there
is also the possibility that environmental liabilities have been erroneously over-stated by the Target. This could
result in key investment opportunities being missed, especially in relation to contaminated land, where recent
changes in legislation may have made redevelopment projects viable, for instance.

A careful examination of the assumptions underlying existing environmental liability estimates (if applicable) is
essential to the due diligence process and may result in unforeseen upside benefits for the acquirer.

Asset Versus Share Transaction

When considering acquiring a Target there are two possible methods of acquisition: one is to acquire the shares
of the company which owns the assets; the other is to acquire the assets comprising the Target.

If shares in a company are acquired, all its assets, liabilities and obligations are acquired (even those a
prospective acquirer may not know about if they have not been identified through the due diligence process).

If only the assets are acquired only the assets (and liabilities) which the buyer specifically agrees to acquire are
identified in the sale purchase agreement.

Due to the limited transfer of liabilities under an asset transaction, the scope of a due diligence engagement
could be significantly reduced — saving both time and money. However, an asset transaction is often more
complex than a share transaction due to the need to transfer each of the separate assets which comprise the
Target and to obtain approvals of any third party contractors or funders. However, a share purchase is often the
subject of more detailed acquisition documents because of the acquirer’s need for warranty protection and tax
covenants in respect of any unrecorded liabilities within the Target.

The key difference between an asset and share sale lie in the nature of what is acquired:

• Share Purchase – acquirer will acquire a company owning the business and running it as an ongoing concern,
with the contracts in place and continuing under new ownership (subject to any change of control provisions).
• Asset Purchase – contracts or existing trading arrangements will not automatically transfer (other than
employment contracts in a relevant transfer) to the acquirer, and these will need to be amended or assigned to
the new owner, which will require the co-operation of the contractor.

The tax issues which both parties need to consider will also be important factors as to the appropriate method
of acquisition of the Target. Generally, the tax advantages to a seller in a share transaction will be greater than
the tax advantages of a share transaction to the buyer, and an asset purchase will often be more tax efficient for
the acquirer than the seller.

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Pricing the Engagement
When using external advisors to perform due diligence, it is important to define the scope of the work required
in the letter of engagement, in order to be clear on the costs to be incurred and to specify what the deliverable
will be — i.e. a summary “exceptions based” report, or a detailed document covering every aspect of the Target.
A summary exceptions based report is usually advisable since it focuses on any key risks identified and is more
reader-friendly.

When asking external advisors for engagement proposals it is important to provide as much detail as possible
to those you are putting the due diligence engagement out to tender with (of course, being mindful of any
confidentiality issues) in order for the advisors to put together a realistic and comprehensive quote. Any time
sensitivities should also be communicated so these can be accounted for in proposals.

If the Target is considered to be “small” there is a risk of not receiving due attention from larger advisors. In
addition to pricing the immediate due diligence engagement it is advisable to ask external advisors to quote for
performing a closing review (for instance — a review of completion accounts or target working capital/net cash/
net debt positions).

It is important to ensure that when comparing proposals from external advisors that you are looking at the same
scope of engagement — essentially, “comparing apples with apples” and that there are no hidden extras you will
become exposed to cost-wise further into the engagement.

If possible, request a comprehensive service package (often covering financial, tax, legal, HR) since it is much
easier to deal with one external advisor. In the case of a major transaction, such as one requiring investment
bank involvement, a “lead advisor” could be used to coordinate/project manage the due diligence process and
any appointed external advisors. In addition to using a single advisor, it is also common to appoint external
advisors to cover the areas of financial and legal due diligence and to cover commercial, HR and operational
due diligence in-house.

If working with external advisors it is important to ask for details of past deals/projects the advisors have worked
on (ideally in the in the same sector as the Target). A specialist corporate finance advisor (often referred to as
a “boutique”) may wish to be considered – for instance, one working exclusively in the TMT sector if the Target
is a technology company. A strong understanding of the sector in which the Target is based will maximise the
chance of the advisor(s) flagging up key issues, price reducers or potential deal breakers.

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 Figure 3 – Suggested Sections of an Exception Based Report

Area in Scope Observations / Recommendations

Findings

• Fixed assets • This section of the • This section of

• Inventory report provides the report outlines
an overview of suggestions for any
• Receivables
key findings from further investigation
• Payables the due diligence which may be
process and required and/or
identifies any risks what protections
requiring attention/ the acquirer may
further investigation seek from the
pre-deal. seller (in the form
of warranties and
indemnities, for
instance).

Preparation
As early as practically possible the acquirer should form and begin briefing the due diligence team. A team
should consist of skilled financial and legal advisors (all preferably with M&A experience — ideally in the sector
of the Target but not essential) as well as being subject matter experts in all key areas falling within the scope
of the due diligence engagement.

Team member’s responsibilities should be clearly defined and a due diligence timeline should be drafted.

External advisors should be considered if the acquirer lacks any of the required expertise necessary for a
successful transaction — for instance, lawyers, accountants, consultants and/or investment-bank.

Since the due diligence process requires a strong element of project management, it is advisable to appoint one
of the selected external advisors to assume a project manager role.

Furthermore, it is advisable to involve the integration team (if applicable) in the early stage of the transaction to
allow them to become familiar with the Target and work more efficiently should the transaction complete.

Due diligence checklists should be drafted to cover the areas in scope (typically financial, commercial,
operational, legal, human resources and other such as regulatory and environmental). These lists should be
comprehensive and tailored to the particular risks associated with the Target.

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Data requests should be prepared and shared with the Target (and their advisors) once the scope of the due
diligence engagement and price has been agreed. Items typically requested include information relating to the
Target’s corporate structure and history, statutory financial statements and supporting management information,
details of key management, operations, real estate and facilities (including finance and operating leases),
intellectual property (IP), key contracts and agreements, employees, suppliers, customers, current/pending
litigation, tax issues, insurance issues, regulatory and environmental issues.

The acquirer should negotiate and sign a confidentiality agreement/non disclosure agreement (NDA). This is
typically issued by the Target and facilitates the exchange of sensitive information while restricting the acquirer
from sharing information with third parties.

Consideration should be given to establishing a physical or virtual (online) data room for the collating of
confidential documents (a virtual data room is cheaper and more efficient, accessible via secure log-in and
depending on the data room chosen allows for users to be provided with differing access rights).

The Due Diligence Process

A detailed internal and external communication plan should be devised, setting out what can be said across the
due diligence engagement, during deal negotiations and into the integration phase.

The due diligence team will be working to confirm the Target’s representations, validate the valuation agreed
in the LOI, investigate any legal, regulatory and compliance concerns, and confirm anticipated synergies and
integration plans. It is also necessary for the team to consider the “soft” aspects of the Target, such as its
corporate culture so as to assess its fit with any of the acquirer’s existing group companies.

Key questions the due diligence team should be mindful of include:

• Are there any problems with the Target, which would force you to abandon the deal, even given a significant
price reduction?;
• Are there any issues that should bring about a change in the structure, terms, or price of the transaction?

To form a conclusion on the above points, and therefore, to establish whether the
transaction should proceed on the terms agreed in the LOI, on amended terms or not at
all, the due diligence team will need to ask questions such as:

• Do the Target’s financial statements accurately reflect the company’s financial position?
• Would the integration of existing operations with those of the Target have any adverse effect on profitability?
• What is the Target’s outlook in terms of its customer base and concentration, its competitive positioning, and
its ability to preserve or increase its profit margins?
• Is the Target exposed to any significant and unexpected regulatory, governance, or liability risks?
• Have future costs (for instance — a pension deficit) been figured into the acquisition value?

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• What is the composition and expertise of the Target’s key management team?
• Do any clashes of culture exist, which could adversely affect integration of the Target with existing group
companies?
• Are there any issues associated with long-term sustainability (for instance - availability of raw materials,
environmental factors) which could affect the Target’s future?
• Who are the Target’s key, value-creating employees, and will they be retained?
• If the transaction is cross-border, do any cultural, legal, tax, accounting, employment, merger-control,
corruption, or environmental concerns exists, which may impact on a successful transaction being achieved?

The due diligence team may be so focused on reviewing their individual sections of the engagement that they
miss the “big picture”, so it is important for the project manager to bring the team together each day so they can
share their findings and adjust the key areas of focus, if necessary.

Due Diligence Etiquette — Key Considerations

• The amount of interaction with the Target — • It is important to advise the Target about the
in particular, key management and employees; burden of the due diligence process and the
• Whether the potential transaction has been resources needed to complete the engagement.
communicated to the employees of the Target In smaller transactions it is possible that key
(and therefore, whether a “cover story” is required staff of the Target will be overwhelmed with work
for any on-site fieldwork conducted); as they respond to due diligence enquirers —
however, no business should be lost because
• The role of external advisors (lawyers,
of the due diligence process.
accountants, corporate finance, consultants,
investment banks); • Aim to combine management Q&A and site visits
with third party advisors for reasons of efficiency
• The expertise and availability of internal
(avoiding repetition of issues being discussed);
resources (such as legal and tax advisors);
• Coordinate external advisors so that all parties
• How much time is available for the due diligence
know each other and all important findings are
engagement and whether either side has set a
being shared with everybody;
deadline for the transaction to complete by;
• Schedule regular catch up meetings/conference
• Request periodic reporting of findings during
calls so that all advisors are on the “same page”;
the process, deal breakers must be highlighted
immediately as they are being discovered so that • All areas of due diligence provide important
the appropriate remedying action can be taken. input to transaction documentation, including
ancillary agreements, seller(s) representations
and warranties, escrow/bank guarantee
requirements, liability caps (if any) and any
specific indemnifications.

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Working with Virtual Data Rooms
A virtual data room (VDR) is an online store of information that is used for the collating and distribution of
key documents in the due diligence process. Physical data rooms (PDRs) have traditionally been used —
however, for reasons of cost, efficiency, logistics and security, virtual data rooms have widely replaced physical
data rooms.

A VDR is set up as the central repository of documents relating to the Target. A VDR enables the acquirer to
view information relating to the Target in a controlled environment where confidentiality can be preserved.

A VDR is designed to have the same advantages as a conventional data room (controlled access, viewing,
copying and printing, etc.) with fewer disadvantages. Where possible it is advisable to have documents in
electronic format — particularly if the data room index is to be used as a basis for the disclosure letter.
Everyone involved in the due diligence process should be mindful of this from the outset in order to track the
documents reviewed.

As the due diligence team progresses through the engagement it may find it needs to make additional
information requests of the Target (corroborating evidence). Using a VDR, requests for information (and
subsequent analysis of this) can be made virtually. However, it is notable that on-site fieldwork (including
contact with key management/staff) is also fundamental to appraising the Target and its potential fit.

Benefits of a Virtual Data Room

• Added Security – documents are usually kept in audited data-centres and encrypted during both storage
and transfer phases. Documents can be password protected and watermarked (or made available as
read-only if desired by the Target). As the administrator, the Target has the power to control security
settings — thereby providing them with assurance over who may review confidential information;

• Detailed Reporting – both the Target and acquirer may receive email alerts about file activity and follow
detailed audit reports back to the source;

• Advanced Tools – VDRs often allow users to drag and drop files and sync account folders;

• Ease of Use – there is no training necessary, and the cloud-based format means you have no additional
hardware requirements.

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 VDR PDR

Concept Digital Physical

Location Online Physical Location - possibly

Target’s premises

Document Format Digital Paper

Data Storage Online Server Physical Room

Data Access (Single or In Parallel – no waiting is Sequential Access – resulting

Multiple) required to access information in a lengthier review process

Recently, thought-leading acquirer companies have turned the tables around when it comes to the due diligence
process. They, as acquirers, have started to invite the Target to their own buy-side platform to answer due
diligence questions and upload relevant documents — rather than sending the due diligence questionnaires to
the Target and relying only on the Target’s provided VDR for information exchange.

A buy-side due diligence platform, such as Midaxo, significantly reduces the buy-side team’s workload and
provides them with the right material at the right time during the due diligence process. It is often much easier
for the Target to produce material to order, than for the Target to interpret existing material designed for other
purposes. Sellers, too, have praised the change provided by a shared platform for increased efficiency and
enhanced collaboration between the parties.

To Buyer To Seller

• Cost Savings - travel cost • Simplicity

are saved • Ease of Setup
• Time Savings • Cost Savings
VDR Advantages • Comfort • Time Savings
• Transparency • Security
• Audit trail of who has
received information

• Reading Documents
Online (preference may
be paper)
VDR Disadvantages • System Speed may
cause limitations
• Information may not
exist in digital form

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How to Report Findings & Negotiate the Transaction
Once the findings of due diligence have been reported, their impact on the transaction can be discussed and the
acquirer can form a clear view of the options to manage any issues apparent with the Target.

• Draft reports should be circulated internally for additional questions and comments;
• No reports should be given directly to the Target’s management — however, key findings will be discussed and
negotiated with them;
• It is advisable to organise a physical meeting with the due diligence team for insightful and comprehensive feedback.

There are four main approaches to addressing issues identified during due diligence:

Price Reduction Closure

• If the initial offer for the Target was predicted on The due diligence report may (i) give the Target the
the basis of “subject to due diligence” it may be “all clear” (ii) identify misrepresentations made by
appropriate to revisit the offer. If this is the case, the Target’s management team or (iii) uncover other
it is important to document the reasons for the issues which could complicate the transaction or
change of position since the original offer outlined render it impossible.
in the LOI.
If the due diligence team has exposed unexpected
• Any change of offer should be linked back to risks these can serve as a basis for (i) reducing
evidence uncovered during due diligence – for the offer for the Target (ii) modifications to the
instance, loss of key customer contracts or representations and warranties required of the
impaired fixed assets (particularly relevant if Target and/or (iii) changes in the section of the
considering an asset based transaction). share purchase agreement addressing post-
closing adjustments and damages.
All due diligence areas could have implications to the
pricing of a transaction but key areas are financial, Post-deal
commercial and legal due diligence (historical and
Some issues such as inadequacies in financial
future performance, synergy benefits and integration
reporting cannot be addressed pre-deal, despite
costs and litigation costs). Of course, collectively, other
the risk they may present to the acquirer. These
areas provide very useful information to support an
can be dealt with using a post-deal plan, whereby
argument in favor of any price negotiations sought.
the Target and acquirer work together post-deal to
Legal Protection validate pre-deal assumptions, develop integration
strategies and commence the delivery of short
Legal protection should be used in instances of
term goals.
uncertainty or for risk mitigation. Warranties and
indemnities are all common outcomes of the due In the worst case, due diligence can result in so
diligence process. Typically these will be included in called “deal breakers” being discovered and the
any Share Purchase Agreement (SPA) with the Target transaction failing.
providing representations at the point of sale. Should
the Target refuse such provisions, the acquirer may
have to be prepared to walk away from the transaction.

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Common Due Diligence Mistakes
• The due diligence team may misidentify the risks associated with the acquisition or may become so
focused on their individual functions that they miss the “big picture”;

• The team may overlook the “soft” but important elements of the Target’s corporate culture;

• The team may disclose anticipated synergies associated with the Target to the Target (leading the
Target to increase their asking price to capture this value, for instance);

• The team may rely solely on virtual due diligence and never conduct on-site fieldwork;

• The team may be so focused on spotting risks that they overlook opportunities;

• The team may so keen for the transaction to succeed that they ignore key risks identified in due
diligence and proceed with the transaction anyway.

Points to Remember
• Understand exactly what you are acquiring;

• Valuations need to be underpinned by effective due diligence;

• Effective due diligence requires a team which knows what it is looking for – therefore, it is important to
appoint team members who can see what others may miss – both in issues and opportunities. If you lack
the requisite in-house resource, reach out to external advisors;

• Consider “deal-breakers” or “deal-amenders” — look for problems with the Target that are fundamental
deal-breakers, forcing you to abandon the transaction. Similarly, look for issues that can bring about
changes in the structure, terms, or price of the transaction;

• Consider both “hard” and “soft” aspects of the Target;

• Give due attention to the retention of key staff;

• Consider due diligence as the first phase of the integration process. The understanding gained during the
process is key to integration;

• If the due diligence team uncovers problems be prepared to walk away from the transaction.

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Key Terms
Warranties – a typical share or asset purchase Indemnities – an indemnity is a “promise” made
agreement (SPA) will contain many warranties. by the seller to reimburse the acquirer in respect of
These are statements about the Target, which a specific liability, should it arise post-transaction.
are given by the seller for the benefit of the The purpose of an indemnity in an acquisition is to
acquirer. Warranties usually cover all matters transfer the risk of a particular event or matter to the
relating to the Target, including specifics relating seller, and to allow the acquirer to recover on a $ for
to financial matters, employees, real estate, and $ basis in respect of that matter or event.
intellectual property.
Indemnities are often used where a warranty may
Warranties serve two purposes: firstly, they provide not allow the acquirer to recover damages: for
the acquirer with a remedy (a claim for breach example, because the buyer had knowledge of
of warranty) if the statements made about the the matter before signing the SPA or because a
Target later prove to be incorrect, and the value of damages claim may not be available.
the company is thereby reduced. Secondly, they
A seller will sometimes provide indemnities covering
encourage the seller to disclose known problems
specific risks, which are of particular concern to the
to the acquirer — as the seller will not be liable for
acquirer. For instance, where the Target is involved in
any matter to the extent that proper disclosure
any on-going litigation, the acquirer may demand the
is made against them. Essentially, the effect of
seller bear the risk of the outcome of the litigation in
the warranties should be to “tease out” potential
the form of an indemnity.
problems about the Target.

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18 | Guide to M&A Due Diligence
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