In this article, I want to share some thoughts on the future of the due diligence (DD) process. The European M&A community will definitely have a lot to add as it is a topic that comes up in each transaction. Hence, I would encourage everybody to leave their comments at the end of the article, so we get an interesting discussion going.
The history of the physical data room where large piles of binders were gathered that needed to be checked seems long behind us. Each buyer was allowed access to the room for a specific amount of time. I wanted to write a full paragraph about the history of the DD process and the physical data room. However, what is there left to say? The future is going to be very different. Hence, in this article, it is probably better to focus on the way the due diligence process will develop over the next decades.
In practice, it might seem slightly surprising that we (or rather, I) as M&A advisors often stay in the background in the DD process. When working with international buyers on large-sized transactions (20 million euros or more) they normally hire external advisors for the due diligence part of a transaction. In cases of very small transactions, the buyer and its team regularly do much of the DD themselves. On the sell side, the virtual data room is often filled by the company’s team of controllers. We stay involved and obviously guide the project where required, but in practice I don’t play an active role in due diligence related activities.
For each acquisition, one needs to look at which parts need attention and what is the scope or level of detail required. It is the obligation of the buyer to perform due diligence. By doing DD, one tries to be as certain as possible that the company meets the description as presented in the previously received material (e.g., information memorandum).
Before deciding on which due diligence workstreams to invest time and resources in, it is important to take a step back and consider the actual situation. Questions that should be asked include, has an LOI been signed? Normally, this is the case and if so, is the LOI binding or non-binding? How long is the exclusivity period if this has been agreed? What is written and agreed to in regard to the valuation of the transaction? Is this a realistic or interesting amount for the buyer? These questions can all have an impact on the level of detail and budget one wants to free up for the due diligence process. The most important due diligence areas are normally:
For more information on these items, one can read further at www.corporatefinanceineurope.eu/due-diligence-mergers-acquisitions.htm.
Vendor due diligence (VDD) has been around for quite some time. In this process, the seller, in cooperation with the M&A advisor of the seller, appoints and pays external advisors to perform different due diligence parts or workstreams of the due diligence process. In practice, we often see a financial DD, legal, operational or commercial DD and possibly more (e.g., environmental) depending on the size of the transaction.
In smaller transactions, we don’t see the VDD process occur, but in transactions above 50 million euros, I think the percentage is growing significantly. Especially if companies are owned by private equity who buy and sell companies on a regular basis.
The rationale of organizing a VDD procedure is to have an efficient process when time is of importance. In this case, the pace is guaranteed and can be kept on track, as all documentation is readily available in the VDD process. In this way, more parties can be allowed to have a detailed understanding of the company for sale. All possible buying parties don’t need to organize their own DD process. Vendor due diligence also keeps control of the process in the hands of a seller (read their advisor) and doesn’t allow a possible buyer to delay and drag on the business sale with an extensive DD process
VDD shows the commitment of a seller, as the company has invested significant financial resources in having the different Vendor due diligence reports readily prepared. This makes the M&A process smooth and efficient. Hence, I expect this trend to continue and grow even further. Especially private equity players that sell larger portfolio companies in an “auction” process will more often revert to a VDD process and have vendor due diligence reports prepared. Further information can be read at www.corporatefinanceineurope.eu/sell-business/vendor-due-diligence.htm.
How active should an M&A advisor be in the due diligence process? What should the role and responsibility of an M&A advisor be?
I see different expectations from clients. Sometimes these expectations have a cost related aspect as a background. From the point of view of a buyer, it can seem of interest to have its M&A advisor perform the full financial due diligence or at least support to a maximum in the process. However, what about operational, commercial or legal DD? An M&A advisor can be expected to be knowledgeable in financial and legal aspects, but this doesn’t mean they are able to prepare full blown due diligence reports. Also, an M&A advisor has an interest in seeing a transaction being consummated, which may result in him or her being less critical. Although this last aspect should not occur, an external firm will always be fully objective. Often, independent DD reports are required and necessary for a buyer to obtain acquisition financing. With this background, the question arises, how smart is it for a buyer to get its M&A advisor actively involved in the DD process? Often the role of the M&A advisor is more related to the coordination of the different pieces of the DD process.
If an advisor supports the seller in the process, the active work is mostly about populating the data room with (financial) data. Here, the actual work is often done by the company’s controller. An M&A advisor guides the process and supports where required.
I am very much interested in your opinion and the experiences you have had with DD processes. What do you see in your daily M&A life as the obligation of the M&A advisor in the DD process? What is crucial in your opinion to get a good and efficient DD process going? Please give your opinion below the article.
An important point in the DD process is often which technical environment to use. In practice, for smaller transactions we sometimes see free providers like Dropbox (or Google Docs) being used. However, it is not clear to me if they are fully in compliance with the desired security levels. There is also a whole list of growing virtual data room (VDR) providers. Their solutions offer more and more options which can be very useful. Especially in larger transactions, this can be of importance. Using a VDR provider can have various advantages. As an example, one can see who accessed which file. Further, access to specific documents can be restricted to only a few designated people. A list of providers and more details on the development of VDRs can be found here www.corporatefinanceineurope.eu/blog/virtual-data-room-vdr.htm
For this part, I would like to ask for your opinion and input. Do you have a clear idea how due diligence processes will develop going forward in the world of M&A? My feeling is that companies will have more internal documentation available in the digital age. Financial figures should be more easily available and quicker to analyze given the regular availability of data in the cloud. However, the main driver is still how business owners have organized their internal processes to make data available. The requirements of a buyer will not change. Their interest will continue to be gaining sound and detailed insight into the actual situation of a company. The infrastructure of VDRs helps to upload and make documents and data available in a shorter time span, so we do see efficiency gains. However, the analysis and understanding of the data still depends on human beings. This continues to be a crucial part throughout the course of performing DD. So, it is still people that determine the length and outcome of a DD process. Please provide your feedback and opinion on this topic. What experience do you have with DD and which developments do you see?
Marc Van den Elsen | Tuesday 8 January 2019 | website: mr. M.J.W. van den Elsen Tax Advisory
Thanks Govert for the clear information brought by the essay. Interesting to see the (newly) involvement of the seller by DD process and the role of the M&A advisor as director in the process.