Acquiring a business venture is not a simple process. While it’s true that it involves a lot of steps, how can you ensure that you are buying the right company? Your verification needs to go beyond the financial information and external details provided by the seller. Due diligence is what you need, and it’s an essential process for both buyer and seller success. What is due diligence? Why is it important? Why do several business professionals give less priority to this process? And, what are the risks associated with inadequate or a lack of due diligence? Read on to know more.
What Is Due Diligence
Due diligence is more than simply checking the financials, books, or business transactions of a target company. It is a detailed investigative process that evaluates the genuineness of the target company. Through due diligence, one can gather details of the affairs of the company that you want to acquire, merge, or make a financial investment in. This investigative procedure helps you identify, analyze, and eliminate the risks and liabilities associated with the acquisition process.
There are different types of due diligence, and each one depends on the nature of the deal or transaction. One can execute financial due diligence, property due diligence, IT due diligence, or environmental due diligence. Irrespective of the type of procedure, due diligence has a single-faced purpose- to genuinely assess the value of the target company.
Why is Due Diligence Important?
When working out an acquisition deal with a company, the buyer or the acquirer will have only limited knowledge about the target company, other than what is generally available in the public domain. Hence, the buyer should recruit professionals like lawyers, chartered accountants, and business bankers who are experts in legal and financial matters to implement due diligence. The seller can do the same to ascertain the fair market value and rectify any non-compliances on his/her company’s behalf.
Due diligence is a very important procedure because it reveals significant loopholes or red flags in matters concerning finance, operations, risk, work culture, strategy, and likewise. It will help the buyer to identify liabilities, if any exist, before closing the deal or transaction. That way, he/she can make an informed decision and avoid potential losses or unnecessary costs later on.
Due diligence benefits the seller also. According to a study, 38% of sellers said that performing more seller due diligence would have been most beneficial to the deal outcome. A fifth thought it would have been best to facilitate the due diligence process by providing more materials to the buyer. Finally, 12% thought they would have benefited by having audited financial statements available before the due diligence process began. As the statistics prove, due diligence benefits the sellers too.
Why Business Professionals Skip Due Diligence?
Some important reasons why business professionals avoid due diligence are:
- They believe that the process is lengthy and difficult, and can delay the acquisition and integration process.
- Buyers also think that due diligence is expensive since it requires the deployment of several lawyers, accountants, investment bankers, consultants, and other professionals.
- Due diligence is also believed to impact the seller negatively as the target company has to answer a plethora of questions from the buyer’s team.
- Several business professionals assume that the process is complicated, stressful, and exhausting.
But, do the above reasons justify the choice of skipping the due diligence process? No. Why can we say that? Because not getting due diligence done is like entering into a deal completely blind and living to regret the wrong choice. Hence, the importance of due diligence outweighs the disadvantages.
How Inadequate or Absence of Due Diligence Impacts An Acquisition Deal
Following are the risks of the lack of proper due diligence:
- You will not know who the suppliers are
As part of due diligence, experts will check the financial viability, quality, control, compliance standards, and, most importantly- records of legal and criminal offences of suppliers. The absence of due diligence will pose potential risks of collaborating with the wrong kind of suppliers.
- You will be in the dark about the target company’s “real” reputation
Without proper due diligence, the buyer will be in the dark about the real reputation and brand image of the target company. You will not be aware of bribery instances or scandals, if any. That can be destructive in the future as you will have limited visibility.
- Overestimation of asset-liability
Some financial aspects can be deciphered only by the experts. Hence, if the buyer decides to skip due diligence, there is a significant risk of overestimating the deal and other assets.
- Higher costs in the future
Since few aspects of the target company have been unknown because of lack of due diligence, it may incur high costs after the deal is made. For example, the buyer may have to invest in new equipment, staffing, and product testing because he/she was unaware that they were non-compliant.
- Increased risk of civil suits
False claims, product failures, litigation matters, etc., can lead to civil suits. Identifying them before the deal will mitigate the risks of going to court.
In a nutshell
A well-conducted due diligence process is vital for a successful acquisition and integration process. It has long-term advantages and will help buyers to avoid severe financial and legal hardships that can damage the reputation of both parties involved. Due diligence follows a systematic approach and will ensure that risks are identified in time and are not passed onto the buyer.
Bowarr Management DIFC has years of experience in Due Diligence in the UAE. Contact us and we will advise you on how to maximize the value of your company.