123’s of Due Diligence in Mergers and Acquisitions

James M. Stanford | 1.3.19

Mergers and acquisitions usually involve a good deal of due diligence before a purchaser fully commits to the acquisition of the target company. Due Diligence is the period in which the purchaser will access the target company’s books and records to verify whether what the purchaser has been told or otherwise believes is true, complete, and accurate. Due diligence is not simply the time to verify the financial position of the target company. Proper due diligence goes much further as the purchaser needs to ensure that it has a reasonable understanding of what it is buying and the obligations it may be assuming. The purchaser also needs to understand the nature and extent of the target company’s pending claims and litigation risks, contingent liabilities, intellectual property issues, problematic agreements, and many other matters.

The following is a summary of some of the primary areas of due diligence that should be conducted in connection with an acquisition.

1. Financial Affairs. The purchaser will need to assess all of the target company’s historical financial statements, records, and related financial metrics along with the reasonableness of the target company’s future projections.

2. Material Agreements. One of the more time-consuming, but critical elements of a proper due diligence inquiry, is the review and assessment of the target company’s material contracts and commitments.

3. Customers and Sales. The purchaser will want to fully understand the target company’s customer or patient base, including the sales pipeline as well as the concentration of larger customers versus a broad base of smaller customers.

4. Employee Matters. The purchaser will need to have a firm understanding of the target company’s management and employee base, including benefits, compensation, past and present claims, and similar matters.

5. Litigation and Claims. Another critical issue is the review of all litigation (pending, threatened, or settled), arbitration, regulatory proceedings, and any other potential claims.

6. Governmental Regulations and Legal Compliance. The purchaser will be very interested to understand the extent to which the target company is subject to and has complied with all regulatory requirements. This can be a critical matter to understand if the target company’s business is in a heavily regulated industry, such as healthcare, where the lack of compliance can be catastrophic.

7. Tangible Property. A thorough review and assessment of all of the target company’s personal and real property, owned or otherwise used in the business, is an essential element of any due diligence investigation, including review of all related loans, encumbrances, leases, and similar agreements.

8. Intellectual Property. The purchaser will want to determine the extent of the target company’s technology and intellectual property, including owned and licensed intellectual property, as well as whether all of the company’s employees and contractors have executed proper proprietary information agreements. Of course, this is even more of a critical issue if the target company is a technology company.

9. General Corporate Matters. The purchaser will need to have a complete understanding the target company’s ownership and control structure, including all of its formation, organizational, governing documents, and general corporate records (including capitalization). This would also apply to all of the target company’s subsidiaries, if applicable.

10. Related Party Transactions. The purchaser will be very interested in fully understanding the extent of any affiliate or “related party” transactions, such as agreements or arrangements between the target company and any current or former officer, director, manager, shareholder, member, or employee of the target company, a subsidiary or other affiliate of the company.

11. Environmental Matters. Depending on the nature of the target company’s business, the purchaser may need to analyze any past, current, and potential environmental issues.

12. Tax Matters. Depending on the structure of the transaction and historical operations of the target company, tax due diligence may or may not be critical. However, an understanding of any tax carryforward and their potential benefit to the purchaser will be important.

While some matters may be more or less important depending on the structure of the transaction and the target company’s business and industry, the purchaser should always involve legal counsel and accountants in the due diligence process. Regardless of the purchaser’s sophistication and experience with M&A activity, there are certain areas of due diligence that will require legal assessment and analysis. Further, even if the purchaser is an expert in the area of financial matters, there is so much that has to be investigated that the purchaser’s time may better spent by hiring a professional to assist with the financial assessment.

ByrdAdatto represents businesses, physician practices, dental practices, law firms, medical spas, and other companies throughout the United States. If you have any questions regarding your business, mergers or acquisitions, or need assistance with designing corporate structure, please contact James Stanford at jstanford@byrdadatto.com or 214-291-3207.