Mergers and acquisitions (M&A) due diligence is the process of investigating the financial, legal, regulatory, and operational viability of a company prior to buying it. Owners of the company are asked to produce documents and provide written answers to questionnaires to satisfy the buyer’s need to exercise an appropriate amount of care when executing a major transaction. The M&A due diligence label is typically reserved for complex corporate transactions on a large scale and the investigation is handled by law firms, but the rationale behind the process is applicable to the purchase of any business, regardless of size.
In the corporate context, an acquisition happens when one company buys another. The acquired company either continues to operate under new ownership or is absorbed into the purchaser and ceases to exist. In a merger, two companies agree to combine operations to form an entirely new enterprise. The individual companies cease to exist and a new company is formed to move forward with the combined assets. M&A due diligence can require the production of information from one party in the case of an acquisition or from both parties in the case of a merger.
Due diligence is a legal standard that requires buyers to exercise care when entering into transactions. This duty of care puts the onus on the buyer to make sure the transaction is legitimate, financially feasible, of sufficient value, and legally binding. Corporate buyers, in particular, have to meet this standard because the officers and directors are acting on behalf of diverse shareholders to whom they have the added duty of maximizing the value of their investment. If the buyer needs to invalidate the transaction because of fraud or any other type of material misrepresentation, the court will look to whether or not it conducted a reasonable investigation into the viability of the transaction before it will allow the buyer a legal remedy.
M&A due diligence is conducted by lawyers in the time period between the deal announcement and the date the deal is scheduled to close, which can be as long as 18 months. The deal won’t close unless due diligence is completed to the satisfaction of all parties. Acquisitions require a complete financial investigation. The seller will have to produce documents, such as financial records, major contracts, and corporate filings, and answer questions about a wide range of matters, including outstanding legal issues, government and regulatory affairs, and stockholder information.
Mergers typically require the added step of conducting organizational due diligence to determine if the cultures of the two companies are compatible. This type of investigation evaluates the company in terms of leadership, strategy, competencies, structure, process, and work philosophy. M&A due diligence concerning organizational matters attempts to prevent a later realization that two companies have such divergent cultures that merging them would detract from the value of one or the other.