3 Secrets on How to Conduct Due Diligence Effectively Without Costing Yourself a Fortune

Is your company considering whether to buy another company?  If so, you probably know that conducting a “due diligence” review of the Seller’s business, and in particular the legal and financial aspects of that business, is critical.

Due diligence allows you as the Buyer to assess whether to move forward with an acquisition and at what price; and, if you do move forward, what terms to include in the deal documents and how to plan the ownership transition.  This assessment can be based on a number of factors, including among others, the Seller’s earning power, the strength of its management, the value and enforceability of its key contracts, and material liabilities and risks that detract from overall value.

So far, so good; but if you’ve been through this process before as a buyer, there’s a decent chance you cringe when you hear the words “due diligence.”  Putting aside the time and energy required to do it right, the due diligence process can be a costly and, not unusually, an excessively costly undertaking.  Put another way, the process can seem like a runaway train that drives professional fees far beyond budget and creates unnecessary distractions to your overall objective: finding a suitable target and closing the acquisition without paying your legal and financial advisors a fortune in fees.

So what can you do now, before it’s too late, to orchestrate an effective, focused, yet affordable due diligence review of a prospective seller’s business?   Having represented many dozens of buyers over the years, I’ve seen what works best and what’s a waste of perfectly good money and time.  Yes, conducting due diligence is critical for any buyer considering an acquisition, but doing it in a way that accomplishes specific objectives at a reasonable cost should be essential to any buyer.

Here are a few of the things I typically advise my clients when we’re putting together a due diligence plan:

1)      Explain your main concerns and objectives upfront.  Tell your legal and business advisors what things really worry you about the Seller’s business.  (Is it weak financial controls?  Lax regulatory compliance?  A demoralized or mistreated group of employees?  Inadequate protection of key intellectual property?)  On the flipside, what can your advisors do to identify, quantify, and test synergies and value drivers in the target business?  In both cases, think about it, and then put it in writing and share it with your diligence team.   Then think carefully about what you want to accomplish in the deal and how you’d like to do it.  For example, if your objective is to get the target’s intellectual property and a few important managers or contracts, let your advisors know so they can think about how to accomplish that.  The proposed deal structure and objectives should, to a large degree, drive the structure of the diligence review.

2)      Set up a staged review process.  Based on your concerns and objectives, lay out a diligence game plan that includes at least two stages of review and be clear about your budget and timing for each stage.

The first stage should be laser focused and done quickly but carefully.  The focus should be on your top-priority concerns and objectives, as well as on certain critical legal questions.  Those critical legal questions may include, for example: what governmental and third-party consents will be needed before closing, what material legal problems (like protracted litigation or repeated regulatory violations) exist, who owns what interests in the target company’s stock, and who owns the Seller’s critical intellectual property.

Work with your legal counsel early in the process to generate a short-list of critical legal issues relevant to your prospective target, and then communicate frequently to be sure the critical focus is maintained.  Also, work with your legal counsel to prepare a list of documents and information that your team will need from the Seller.  This diligence request list should be tailored to reflect concerns you’ve outlined in your legal issues list.  Once the first-stage review is complete, assemble your top legal and business advisors and review what each has found.  It’s important that before you move to the second stage, your advisors are talking to each other and sharing thoughts and opinions in a candid and constructive way.  One key question that should be answered at this point is: based on what everyone has seen, does it make sense to move forward with the acquisition?

The second stage should start once you’re comfortable with what you saw in the first stage and should be somewhat less focused and a bit more open-ended.  Not that your legal team should look under every single stone, but give them license to look for the less obvious risks and problems in the Seller’s business.   Then give your advisors a deadline by which to deliver some form of written work product.

3)      Be clear what you want and need from your advisors in terms of written work product.  You might want an exhaustive memorandum from your lawyer summarizing every document reviewed and listing primary, secondary, and tertiary issues, but understand that will cost you lots of money.  In many cases, it should be enough to get a condensed “issues list” that articulates your lawyer’s main concerns and provides talking points that you can discuss in greater detail.  Alternatively, ask for an “executive summary” that provides an issues list and your lawyer’s brief explanation of why each issue is listed and what it means for the deal.  In a situation where the Seller’s business has a large number of contracts, many subsidiaries, or is otherwise large and complex, a more lengthy diligence memo may be called for.  Among other uses, the memo can be used in the process of reviewing the Seller’s disclosure schedules to identify disparities and confirm the schedules are complete.  But in any case, get something in writing so you, your lawyer, and your other advisors are on the same proverbial page when it comes to identifying important facts discovered and conclusions reached during the course of the diligence review.

So, if your company is looking to acquire another business, do you have a diligence plan in place yet?  If not, why not?  Without a well-considered plan, it’s likely the due diligence review is going to cost you a fortune and yield mixed results.  Take a different approach: start today by using the suggestions I’ve explained above to structure a focused, affordable, and ultimately effective diligence review process.

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2 Responses to “3 Secrets on How to Conduct Due Diligence Effectively Without Costing Yourself a Fortune”

  1. This piece is an excellent roadmap for any firm considering aquisition. Thoughtful planning from the start will set expectations and reduce costs. What simple and practical advice!

  2. Great post. If your advisor team is not proactively seeking guidance re: your priorities and focus as the principal/client in our modern, fee-conscious environment, something is not right.