Harnessing Alternative Data to Perform Due Diligence in Mergers and Acquisitions
August 30, 2021
Due diligence is a significant process when evaluating and conducting business or investment decisions. It allows the buyer to have a granular understanding and a correct assessment of the target company’s risks, strengths, and weaknesses. Typically, due diligence pertains to collecting and analyzing company information strictly.
However, with the wide adoption of alternative data and a variety of sources, this process has delivered richer and more accurate insights over the years and has consequently expanded to collect and analyze a variety of data sources. This has helped buyers be more equipped with the necessary information to close the deal with more confidence and certainty. Let’s see what role due diligence plays in mergers and acquisitions and how alternative data can enrich this process.
What is M&A due diligence?
Due diligence is the process that allows you, as a buyer, to appraise a business before a merger or an acquisition. It involves a deep exploration of all business dimensions, ranging from strategy and vision, finance and legal aspects, and operations and assets.
Businesses, entrepreneurs, and investment firms utilize M&A due diligence so they can better understand the organizational and financial aspects of a business they are interested in acquiring. Additionally, due diligence involves making sure one is compliant with all the regulations, such as contractual obligations or corporate governance. At this stage, you may obtain the certainty that the business is the best target that suits your strategy, or you may reveal unforeseen risks or problems. When M&A due diligence is carried out successfully, it allows you to make the optimal decisions.
However, the success and accuracy of M&A due diligence are dependent on numerous factors. It is important to be carried out at the correct time and be deeply rooted in accurate, rich data. Any slight oversight can be detrimental to your success.
Types of due diligence
There are several types of due diligence necessary for a potential M&A deal. Some of the most important ones include:
- Accounting due diligence focuses on ensuring that all the financial information provided to the buyer is accurate, honest, and up to date.
- Business due diligence can be enriched with external, alternative data regarding the business and is conducted by verifying that the business has growth potential and that its financial performance is sustainable.
- Legal due diligence refers to specialists checking the corporation’s legal background, ensuring that there are no issues or liabilities.
- IT due diligence refers to checking the company’s IT risks or problems.
- Environmental due diligence refers to analyzing the acquired company’s environmental risks and long-term sustainability.
- Financial due diligence is based on researching the target company’s financial matters.
What is the M&A process?
The M&A (mergers and acquisitions) process refers to all the steps you need to take to acquire or merge with another company. This contains planning, research, the due diligence process, and closing the deal.
In most cases, the M&A process has the aim of executing an acquisition or a merger to improve your firm’s strategic or competitive position in the market. Also, there are several other side benefits of a successful M&A deal:
- Improve business relationships between security holders and buyers
- Expand product portfolio and diligence report
- Enhance brand perception and recognition
- Improve sales pipeline capacity
- Boost operational efficiency
- Achieve economies of scale and discover cost savings
Mergers and acquisitions are significant corporate actions – perhaps, the only ones that can reshape the company and the entire industry. Every industry leader has merged or acquired another target company at some point and for various reasons – to decrease competition, access a new market, or to proprietary technology or intellectual property. Regardless of the purpose, there are a few general steps involved in the M&A process:
- Develop the M&A strategy
- Establish searching criteria
- Obtain a list of potential target companies
- Perform valuation analysis on target companies
- Choose the right company and start negotiations
- Send the letter of intent
- M&A due diligence process
- Final offer and close the deal
This M&A process can take anywhere from several months to several years, depending on the complexity of each company.
What are M&A strategies within due diligence?
Due diligence refers to the process which aims to discover and confirm the acquired firm’s value for the M&A process. It may entail different steps based on the type of your deal. Some of the main components include cultural fit, strategic fit, and operational suitability. The main outcome of M&A due diligence is to ensure that you have assessed the business at its actual value, identified all the risks correctly, and potential integration or deal breaks that would render the entire transaction.
When coupled with alternative data, you can expand your due diligence objectives to include insights into the workforce, critical supplies, key products, performance, competencies, technologies, and even R&D, among others.
Due diligence contains several functions, including human resources, corporate strategy, legal aspects, marketing, procurement, and more. The M&A strategy should be based on a due diligence checklist that is comparable between businesses.
For instance, you can compare your business with the one to be acquired, so you can identify gaps or opportunities for improvement after purchase. This validates the benefits of the synergy, merger assumptions and offers you an actionable plan for integration after the acquisition or merger.
Due diligence may look at different aspects, depending on the business to be acquired. Traditionally, the main sources of information would entail public records, company history, SEC filings, and forecasts for public companies. However, for private companies, the information is scarcer and, in most cases, comes from the company’s own internal data management systems.
Alternative data now enables businesses and individuals to make optimal decisions by providing a rich source of information regarding a firm’s competitors, social media presence, job listings history, and many more, using the company’s digital imprints. As alternative data is collected from a wide range of sources, it can be used to gauge a business’ performance better, going beyond traditional data sources.
How do you perform due diligence for an acquisition?
Due diligence is a crucial part of an acquisition. Even more important, it is vital for both parties – the seller and the purchaser. If the due diligence process is conducted successfully, it should lead to correct, fair pricing of the business while reducing risks that could delay or even stop the transaction at a later time.
Down to its core, acquisition due diligence is about investigating the business to be acquired. It should focus on all the aspects and numbers that could influence the buyer throughout this process. This process is also common when an investor or a venture capitalist considers investing in a startup or a more mature firm.
Before entering into any M&A transaction, venture capitalists, private equity firms, and other interested parties must thoroughly research and investigate the financial and legal aspects of a given company. When purchasing another business, this due diligence process may focus more on assets and liabilities, market standing, legal or financial obligations, and other firm-specific aspects that might change the buyer’s mind throughout the process. In short, due diligence in an acquisition is about determining the feasibility and value of the M&A deal before closing it.
Due diligence objectives
The main purpose of due diligence is to make the buyer more confident and comfortable with the acquisition of the company. In most cases, business acquisitions are extremely capital-intensive. You would undoubtedly want to ensure that your funds are well-invested, so you can earn future returns.
A due diligence report aims to provide this understanding and inform you of any unexpected risks or aspects within the company to be acquired. As a result, due diligence aims to protect you against negative aspects after buying the company. Some other due diligence objectives may include:
- Identify possible risks or issues
- Find out about aspects not yet discussed with the seller
- Find out the real value of assets and liabilities
- Due diligence reports are often used to obtain bank financing
- Potentially renegotiate the purchase agreement
- Identify future opportunities for business improvement
Steps in acquisition due diligence
Undoubtedly, acquisition due diligence is a very thorough and complex process. Its steps may depend on the type of deal you seek to invest in, your objectives, and your data sources. As a result, every M&A process may be different in terms of requirements, steps, and methods that need to be used for its successful completion. More specifically, the due diligence process must fulfill the requirements of your deal.
Despite this, here are some of the more common steps involved in due diligence processes that any investor or business can follow.
Initial evaluation of the goal
Firstly, you need to establish your objectives. For instance, you need to clearly define what corporate or investment goals you expect to achieve following the acquisition and what benefits or aspects you seek to validate through the due diligence process.
This step is important as you need to contact the seller and any authorities that may grant you access to the information you need. All M&A deals are unique, so the type of information you need is based on your objectives, the target company, and your corporate or investment goals. For public or large companies, this step can be conducted easily, while private companies may lack transparency and data availability. However, it is important to consider while confidentiality is important, sellers that are unwilling to disclose accurate information such as financial statements, intellectual property contracts, and ongoing business transactions must be thoroughly vetted.
At this stage, the buyer should know what questions to ask the seller – such as relevant documents you need access to and perform on-site visits. For this step, it is important for the seller to be transparent, honest, and highly responsive to facilitate your access to information. For instance, sellers should provide accurate information surrounding intellectual property rights, financial performance, financial statements, historical income tax liabilities, stock option agreements, and more.
Due diligence process
Next, the buyer analyzes all the information collected and adopts a holistic approach to assess the target company. You should identify if the firm fits your business goals and clearly assess all the risks involved in the M&A. Some things to consider when preparing the final offer are cost savings, income statements, the diligence report, current employee contracts, and overall corporate development.
Make the Final Offer
Finally, after you have a clear insight into the target company, you should be able to understand the correct valuation. All the steps above help you create a fair estimate of the amount.
How long does M&A due diligence take?
As in the case of the overall M&A process, due diligence can take time. It is important to have quick access to all the information you need but, even in this case, collecting and analyzing massive datasets can be extremely time-consuming.
Some specialists state that, in general, the M&A due diligence takes from 60 to 90 days to complete. In some cases, it may take longer than three months, but most parties would find that a lengthier due diligence process can negatively impact the deal.
The benefits of performing M&A due diligence
There are several benefits of M&A due diligence processes. First, you will be able to adjust your M&A expectations as you get to know the target company. This process will reveal a complete view, ranging from how the deal will play out to how smooth the integration will be.
Next, you will be able to understand all the potential risks involved with your merger or acquisition. This allows you to develop appropriate risk management techniques, mitigate these challenges, or simply renegotiate your deal based on the new information. This is even more important if your target company has legal or financial risks you are unaware of when you start negotiating in the first place.
Another benefit is that M&A due diligence will also help you plan out the integration process. As a result, it helps you save time by ensuring that everything goes smoothly after the merger or acquisition.
Finally, the due diligence process requires the two parties to communicate before the merger and acquisition. Apart from building great working relationships with the seller, you will also be able to have a better understanding of the rapport between the companies before the merger or acquisition. Also, you will be able to check the cultural fit with your own corporate culture.
Challenges of due diligence in M&A
The M&A due diligence process is vital when it comes to such capital-intensive transactions. However, there may be a myriad of challenges that will make it difficult to understand the other company. This may eventually lead to delays or even canceled transactions or offers. Some of the main problems that arise during M&A processes include:
Slow access to information
Asking sellers to provide all sorts of documentation and information can take a lot of time, especially if the seller is not prepared for your questions and requests. Usually, this leads to massive delays in the entire process.
Not knowing the right questions – another important aspect is that each company is unique. To know everything about the target firm, you should know exactly what information to ask for. In a data-driven society, any company can have massive amounts of data that might be either irrelevant or too time-consuming to analyze. As a result, as a buyer, you should know in advance what type of questions to ask the seller, so you can have access to the most relevant data.
Lack of responsiveness or communication
Unfortunately, not all sellers might be interested in the due diligence process; in fact, some of them might regard it as a hassle and treat it with impatience and rushed poor communication.
Most of the data you will obtain traditionally will have to be collected and analyzed by professionals. As a result, due diligence can turn extremely extensive and drag the process over many months.
Lack of expertise
Some datasets, especially those collected from the company’s internal systems, might not be ready for interpretation. It is highly likely that you will have to bring experts to help you turn raw data into information that can be easily understood and in a form that facilitates your decision-making process.
Benefits of using alternative data for due diligence in M&A
Fortunately, most if not all of the challenges mentioned above can be dissolved using alternative data. In short, there are several types of alternative data you can use in your M&A due diligence process to improve accuracy and speed it up:
Firmographic data, such as size, industry, category, and other identifiers, can help you in the initial stages of selecting potential target companies.
Company employee reviews alternative data helps you obtain a clear, objective insight into your selected company’s workforce. This can be easily used to perform sentiment analysis, so you learn more about how the employees feel about their workforce. In turn, you can compare this with your company’s culture to identify compatibility or issues. Also, you can easily identify risks as negative employee reviews are a potent sign of bubbling internal issues that you might not find out using traditional data.
Company funding data allows you to access the specific investment stages and the amounts raised by your target company.
Job postings data provides you insight into the company’s growth and hiring activities to better understand its business strategy.
Tech product review data help you identify the market sentiment for your target company’s specific products, which is important for correct valuation. You can further enrich this step with technographic data, which provides an insight into the company’s technological stacks, tools, assets, and even technology online mentions.
All in all, due diligence in M&A is a complex, lengthy process in which you seek to obtain detailed information regarding your target company. It helps the buyer protect themselves from unforeseen risks, correctly valuate the chosen company, and even start planning the implementation process. Fortunately, alternative data have become more accessible, and many investors or buyers can now access them to make more accurate business and investment decisions. The profitability of the deal and the smooth integration process undoubtedly depend on your ability to conduct the M&A process in such a way that you minimize your risks and challenges.
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