An M&A process at a glance (III): Due diligence

A successful M&A process (a merger or acquisition of one or more companies) requires more than just agreement on the price. In this blog series, we discuss step by step the key legal phases of an acquisition: from the letter of intent and due diligence to warranties, indemnities, financing, the purchase agreement, and the period after closing. We share practical insights from our daily practice, aimed at entrepreneurs, investors, and advisors who wish to keep control over the acquisition process. In this third episode, we focus on the process of due diligence, the book review. 

Due diligence in an acquisition: what is really being looked at?

After the Letter of Intent, due diligence research usually follows. For buyers, this is the moment to verify whether the company is indeed what it appears to be at first glance. For sellers, this is often the phase in which the organization, documentation, and internal processes come under a magnifying glass. Due diligence is therefore one of the most determining elements of the acquisition process.

What is due diligence exactly?

Due diligence is the investigation that a buyer has conducted into the company they are interested in. This investigation serves multiple purposes. It helps to verify the accuracy of assumptions, map out material risks, and determine which issues should influence the price of the company, the structure of the transaction, and/or the underlying contracts. It's not just about finding problems, but primarily about interpreting what is relevant.

What topics are covered?

The content of due diligence depends on the company, the sector, and the nature of the transaction. In practice, we often see a combination of legal, financial, and tax research, supplemented with commercial, operational, IT, or ESG-related workflows.

Legal due diligence, for example, focuses on the corporate structure, shareholder agreements, material contracts, financing, securities, disputes, employment relationships, intellectual property, permits, compliance, and privacy. Financial due diligence looks more at EBITDA, quality of earnings, cash, debt, working capital, and possible normalizations. Tax due diligence focuses on historical filings, tax structures, and specific risks.

Not every point of attention is a problem

A common misconception is that every identified risk is automatically a dealbreaker. In reality, due diligence is primarily about materiality. An incompletely signed contract is different from a change of control clause in a core relationship. An internal privacy document that needs updating is different from a structural violation of laws or regulations. And a dependency on one key figure or client may be acceptable to one buyer, while another buyer sees it as a fundamental risk.

The value of due diligence lies not in the number of comments, but in the ability to distinguish between main and secondary issues.

A dataroom is crucial for sellers

The way information is shared often says a lot about the quality of the process. A well-organized dataroom speeds up the investigation, prevents duplication of work, and contributes to trust. A messy flow of information, inconsistent answers, or missing documents often leads to additional questions and increased reluctance on the part of the buyer.

More and more sellers are therefore choosing to clean up internally in advance or even to have a vendor due diligence conducted. This allows a company to identify potential bottlenecks earlier, resolve them possibly before the transaction itself, or determine better how they should be presented in the process.

What happens to the outcomes?

The results of due diligence usually affect three aspects. Firstly, they can influence the purchase price. Secondly, they are translated into warranties, indemnities, or other clauses in the purchase agreement. Thirdly, they can impact the structure or timing of the transaction, for example, if third-party consent is required or if a specific risk needs to be resolved first.

Sometimes a finding leads to a lower price. Sometimes a targeted indemnity is a better solution. And sometimes a buyer concludes that the risk is too great to proceed with the transaction. Once again, the process relies on thorough preparation.

W&I insurance is not a substitute for good research

In larger transactions, the possibility of Warranty & Indemnity insurance (a W&I insurance) often comes into play. Such insurance can help cover some of the warranty risk in certain situations. However, it does not replace due diligence research. Insurers expect that the buyer has conducted thorough research and will often exclude certain topics from coverage.

Thus, due diligence is not a formality, but the moment when the buyer's assumptions are tested against the reality of the company. If you want to know how to best prepare for a due diligence investigation as a buyer or seller, or if you want to concretely have a due diligence investigation conducted, we would be happy to assist you.