Mergers and acquisitions (M&A) create many opportunities, but they also bring risks. Before any M&A transaction, it’s important that you perform thorough due diligence.
An M&A due diligence checklist can help with this process.
A well-crafted acquisition checklist should consider the buyer's specific requirements, the characteristics of the entities involved, their management and ownership structures, industry dynamics, and company histories. Additionally, the checklist should be adaptable, with the level of detail varying based on the nature of the transaction including size.
Below are typical due diligence areas that must be addressed in an M&A deal.
General corporate matters
Gather organizational documents and corporate records for a company and its subsidiaries. Including:
- Articles of incorporation and amendments
- Bylaws and amendments
- Meeting minutes
- Organizational charts
- List of current officers and directors
- List of shareholders and the number of shares each holds
- List of all states the company is qualified to do business in
- Business licenses and permits
- Good Standing and tax authority certificates
Financials
To gain a thorough understanding of the company’s financials, review the following:
- Cash flows
- Balance sheet
- Quality of earnings
- Accounting compliance
- Any significant operating and financial trends
- GAAP and SEC reporting compliance
- Valuation and financial modeling
- Operating or SG&A (selling, general, and administrative) expenses
Tax
Evaluating tax reports, filings, and agreements can help inform potential risks and opportunities in the transaction. Examine:
- Federal, state, local, and foreign income or other tax filings
- Sales and use tax reports
- Audit and revenue agency reports
- Tax settlement documents
- Tax sharing or tax benefit agreements
- Employment tax filings
- Tax liens
Legal
The main goal of legal due diligence is to discover hidden liabilities – whether historical or pending – that could compromise the transaction. Be sure to perform the following:
- Legal history review
- Past and pending litigation review
- Bankruptcy searches
- Unpaid judgments and liens
- Preliminary UCC searches
- Legal entity structure mapping and post-close filing preparation
- Legal obligation review
- Debt structure and credit analysis
Antitrust and regulatory issues
The U.S. Department of Justice and U.S. Federal Trade Commission have upped scrutiny and enforcement of antitrust practices. Conducting antitrust due diligence can inform buyers of the antitrust liability risk associated with any transaction so they can take mitigating actions.
Due diligence should also review all regulatory obligations, business licenses and permits, and certification requirements to identify potential non-compliance with industry regulations.
Consider the following:
- If the purchaser is a competitor of the target company, it's important to grasp and navigate any restrictions set by the company concerning the extent and timing of due diligence disclosure.
- In cases where the company operates in a regulated industry and necessitates regulatory approval for an acquisition, understanding the complexities surrounding the pursuit and obtaining approval is crucial.
- Review industry-specific business licenses and certifications.
- Confirm if the company has been subject to antitrust or regulatory inquiries or investigations.
Material contracts
Buyers should be vigilant regarding any contracts held by the target company that have the potential to affect the company adversely if they are terminated. Examples include:
- Credit agreements, guaranties, and loans
- Real estate leases/purchase agreements
- Material contracts with suppliers or customers
- Manufacturing contracts
- Partnership or joint venture agreements
- Equity finance agreements
Insurance
Review each insurance policy held by the target company, including:
- General liability
- Personal and real property
- Product liability
- Errors and omissions
- Key-man, directors, and officers
- Worker’s compensation
Commercial
Commercial due diligence offers insights into the target company from a business standpoint. Typically, this involves an in-depth analysis of various factors that are commercially significant and provides insights into the target company's operating landscape and its prospects. There are several areas to cover:
- Evaluate strategy and growth plans
- Interview customers to assess sales and marketing results
- Business plan review
- Overall competitive analysis
- Understand brand value and customer loyalty
- Review marketing strategies and arrangements
- Review sales, distributor, agency and franchise agreements
Operational
The goal of this step is to understand daily operations, business efficiencies, and uncover any issues. Consider the following:
- Working capital assessment
- Manufacturing and operations evaluation
- Inventory reports
- Subcontractor, supplier, and vendor list and contracts
- Procurement and supply review
- Supply chain operations
- Capacity analysis
- Analysis of capital expenditures
- And more
Property and assets
Review of all owned or leased property, including:
- Valuation of property, equipment, and other tangible assets
- Deeds, leases, and subleases
- Rental income
- Financing agreements
- Conditional sale agreements
- Environmental site assessments
- Liabilities and obligations (liens, mortgages, property tax, etc.)
Management and workforce
General management and workforce considerations may include:
- Key employee listing with salary, title and duties
- Employment contracts and agreements
- Employee and retirement benefits
- Compensation plans
- Description of labor disputes
Technology and data
Performing technical due diligence allows stakeholders to make informed decisions about the company's technological preparedness and integration readiness. The review should include:
- IT infrastructure
- Software applications
- Data management practices
- Security and data protection policies and controls
Intellectual property
Intellectual property due diligence audits the scope and quality of any IP assets held by or licensed to the target company or individuals. This step should also address how IP is captured and protected by the company.
- Obtain a list of trademarks, copyrights, patents, trademarks, trade names, or service marks, both current and pending
- Confirm ownership of IP
- Assess the quantity and quality of IP assets
- Value intangible assets
- Evaluate how IP is captured and protected to prepare for a transaction
Corporate Transparency Act issues
In 2024, there was a significant shift in the mergers and acquisitions (M&A) market in the United States due to the enactment of the Corporate Transparency Act (CTA). This legislation, aimed at addressing the misuse of shell companies and enhancing ownership transparency, requires “reporting companies”, which include both domestic and foreign entities operating within the U.S., with certain exemptions, to file a beneficial ownership information (BOI) report, containing detailed disclosures to the Treasury Department’s Financial Crimes Enforcement Network (FinCEN).
Importantly, exemptions granted to one entity within a corporate structure may not necessarily apply to others. Therefore, each entity involved in an M&A transaction requires individual assessment for compliance with the CTA.
Potential buyers and companies targeted for acquisition should thoroughly assess the implications of the CTA regulations, including the following issues:
- Are the potential targets reporting companies, and if so, have they filed their initial report yet?
- What impact, if any, will an acquisition have on a target’s status as a reporting company or an exempt entity?
- Who will be responsible for the target’s CTA compliance post-acquisition, the target or the buyer?
- If the target is a reporting company who will be the target’s beneficial owners after the acquisition?
- What changes need to be made to the buyer’s and target’s governing documents regarding the companies’ and their beneficial owners’ reporting responsibilities under the CTA?
Getting started
Due diligence plays a crucial role in enabling dealmakers to understand a transaction's nature, assess risks, and determine its compatibility with their portfolio.
However, business deals and strategic decisions often unfold with strict time constraints. The pressure to meet deadlines can limit the thoroughness and comprehensiveness of the due diligence process. This can lead to overlooked details, incomplete analysis, and uninformed decisions.
Engaging the services of the right partner can ensure your due diligence is thorough and successfully completed. Whether in the initial phases of due diligence or during the intense moments of finalizing the deal, CT Corporation provides the merger and acquisition support services that you can count on to finalize the deal.