The Different Types of Due Diligence in Mergers and Acquisitions (2024)

Due diligence can make or break business transactions. Sometimes you discover information that confirms the benefit of buying the target company or starting a new venture. Other times, you could find issues that need contingency plans or deter you from moving forward. Regardless of what you learn, there's no denying that it's better to know upfront so that you can plan accordingly. This starts with identifying the types of due diligence in mergers and acquisitions that affect your business. Then you can formulate a plan for a smooth transition.

The 7 Main Types of Due Diligence in Mergers and Acquisitions

There are several different ways to categorize M&A due diligence. Consequently, you might come across only 3 types of due diligence and find this is enough to meet your business needs. Still, one can never be too thorough with preliminary investigations, so consider using all seven.

1. Financial Due Diligence

The target company's financial performance is one of the most critical elements you must review. Financial health ensures you have the cash flow and profitability necessary to achieve your expected return on investment or higher. Auditing financial documents could also unearth errors or fraudulent activities that the target company must resolve.

You can hire accountants, tax lawyers, and appraisers to assist with the financial due diligence process:

• Auditing the company's financial records
• Reviewing accounting policies and investment strategies
• Analyzing cash flow vs. expenses
• Reviewing historical performance and predicting future milestones
• Evaluating earnings quality
• Appraising the value of assets, such as real estate, intellectual property, and inventory

2. Legal Due Diligence

Litigation is one of the most expensive risks a company can undertake. This makes the legal aspects one of the most critical types of due diligence in mergers and acquisitions. It helps you determine the risk level for these and other legal factors. All organizations must follow specific regulations related to their industries, as well as payroll, accounting, and product safety.

Ideally, you work with industry experts such as attorneys for this step. Here are some of the tasks they can assist you with:

• Examining contracts, agreements, licenses, and permits
• Identifying potential liabilities that could arise from the acquisition
• Reviewing any pending or past legal actions involving the target company
• Assessing compliance with laws and regulations related to taxes, labor, and environmental health and safety

3. Operational Due Diligence

Operational due diligence examines various aspects of production and workflow. It assesses whether the company has efficient processes, policies, procedures, and systems to operate effectively. Ideally, you work with consultants or industry professionals to determine the operational risks and potential for improvement.

Operational risks are often among the easiest to rectify of all the types of due diligence in mergers and acquisitions, but this can vary. For example, if you find expensive bottlenecks, redesigning the workflow may solve this. Righting outdated machinery and noncompliant contract relationships require more capital investments and time.

You should evaluate these critical areas:

• Operational structure and organization
• Quality control processes and procedures
• Supply chain management
• Technology infrastructure and systems
• Customer satisfaction levels

4. Human Resources Due Diligence

People are a company's most valuable asset, which makes HR one of the most important due diligence types. HR due diligence examines employment agreements, compensation packages, labor relations, and salary structure. It also assesses whether the target company complies with applicable employment laws.

Consider interviewing employees to get a feel for the company culture and the current satisfaction levels. Taking over a company while workers have voiced dissatisfaction with work conditions or salaries could mean navigating strikes soon after.

Hire human resources experts to help you navigate the following tasks:

• Reviewing employee contracts, handbooks, and training manuals
• Evaluating pending or past lawsuits related to employees
• Assessing employee satisfaction levels and retention rates
• Examining compliance with labor laws, such as minimum wage and overtime regulations

5. Intellectual Property Due Diligence

IP due diligence is crucial if the target company has unique products or services that give it a competitive advantage. This is one of the most critical types of due diligence in mergers and acquisitions if the company uses IP owned by other entities. It is not uncommon to find that many of the related agreements survive on a previous handshake deal and have no clear contracts.

You must ensure the target company owns all the necessary patent or licensing rights to produce its goods or services. Attorneys can help you with these and several other tasks related to IP:

• Reviewing patents, trademarks, and copyrights
• Identifying any infringements on the target company's IP
• Identifying potential violations committed by the company
• Verifying agreements and contracts related to IP ownership or usage
• Drafting and reviewing contracts to solidify existing agreements

6. Environmental Due Diligence

Sustainability is a top priority at multiple levels. The new generations of workers prefer companies that take a stand on green issues, such as becoming carbon neutral. Millennials and Gen Z are also more likely to buy sustainable alternatives to everyday products. Meanwhile, governments worldwide have launched campaigns calling corporations and consumers to choose eco-friendly options.

Is the target company poised to succeed in this new reality? How far away is it from carbon neutrality? How important is this for your target customers, potential workers, and regulating agencies? Too many companies underestimate this compared to other types of due diligence in mergers and acquisitions.

There are many tasks you should undertake to help you answer these and other critical questions about sustainability:

• Assessing the target company's environmental impact and sustainability practices
• Reviewing compliance with environmental laws and regulations
• Identifying potential risks related to pollution, waste management, and resource usage
• Evaluating any past or pending legal actions related to environmental concerns
• Analyzing the target company's carbon footprint and potential for improvement

7. IT Environmental Due Diligence

IT environmental due diligence is crucial for any company in today's digital world. It examines the target company's technology infrastructure and systems to identify potential risks. Pay special attention to data security, privacy, and compliance with relevant laws, such as the General Data Protection Regulation in Europe and the California Consumer Privacy Act in the United States.

You need IT, compliance, and legal experts to assist with this step of the due diligence process. Be sure to complete these tasks that differ from other types of due diligence in mergers and acquisitions:

• Assessing the target company's cybersecurity protocols and policies
• Reviewing data protection measures, such as encryption and access controls
• Identifying potential vulnerabilities in the target company's systems and networks
• Evaluating compliance with data privacy laws and regulations
• Assessing disaster recovery plans and backup procedures to protect against data loss

The Role of Information Technology and Infrastructure in M&As

Technology affects every aspect of modern life, from how businesses operate to how everyday people interact with organizations. Corporations have a wealth of options, and they do not necessarily work well together. Consequently, IT considerations continue after the initial due diligence.

For example, merging a company that uses Apple technology with one that uses Microsoft will take time. Imagine what this means post-merger and the work it will take to align both systems. You will need a team of IT experts to assist with the process of identifying the best cloud option and productivity tools. You also need a plan to overcome resistance.

Additionally, IT experts are critical for the data migration process that follows the many types of due diligence in mergers and acquisitions. Professionals follow best practices when migrating data to reduce the risks of hackers gaining unauthorized access or creating backdoors during the move.

Why Prioritize IT in Your Mergers and Acquisitions?

Prioritizing IT considerations in mergers and acquisitions comes with a multitude of benefits. Here are some of the main reasons you should move this to the top of your due diligence checklist:

1. Operational Efficiency: Getting both IT environments to work well together can save you time and effort. It reduces frictions caused by miscommunication and stalled operations. Efficient data integration facilitates collaboration, which enhances productivity across the board.
2. Cost Savings: Proactive IT due diligence can identify redundancies and inefficiencies in the existing systems. These present opportunities for reducing costs by cutting unnecessary weight from the IT infrastructure.
3. Risk Mitigation: You can identify potential security threats and compliance issues well in advance. This foresight makes it easier to mitigate the associated risks. This strengthens the business against cyber threats and legal repercussions.
4. Strategic Advantage: One common reason for M&As is to acquire game-changing technology, such as when Google bought Android. Leveraging technology effectively can also open up new avenues for innovation and growth.
5. Smooth Transition: Prioritizing IT in M&As facilitates an easier transition for employees, customers, and partners. It reduces confusion, minimizes downtime, and maintains business continuity during integration.

How Cloudficient Can Help With IT Types of Due Diligence in Mergers and Acquisitions

We are cloud migration experts. Our experienced professionals work closely with companies during mergers and acquisitions. Our work spreads across several types of due diligence in mergers and acquisitions, such as IT, operational and legal, due to the impact of technology on compliance and work processes. Let us help you navigate these complex areas. Schedule an appointment with Cloudficient to get started.

With unmatched next generation migration technology, Cloudficient is revolutionizing the way businesses retire legacy systems and transform their organization into the cloud. Our business constantly remains focused on client needs and creating product offerings that match them. We provide affordable services that are scalable, fast and seamless.

If you would like to learn more about how to bring Cloudficiency to your migration project, visit our website, or contact us.