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CT Expert Insights: Due Diligence Essentials for M&A

Whether you’re buying an asset or company to merge with or run independently, due diligence provides you with a complete picture of what you’re getting into before you make the deal.

By completing research prior to closing the deal, you’ll have accurate information to help you decide if you’re prepared to move forward with your M&A or if you need to renegotiate. Learn about the various types of due diligence, including financial, legal, IT, intellectual property, reputational, regulatory, operational and commercial.

CT Corporation Strategy and Innovation Manager Ian Bone gives a brief overview of what due diligence is, why you should do it, and what could happen if you fail to research your deal prior to closing.

 

TRANSCRIPT

Greg: Hi. I’m Greg Corombos. Our guest this week is Ian Bone, Senior Manager of Strategy and Innovation at CT Corporation. Today, we’re talking about the best approach to due diligence when it comes to mergers and acquisitions. Ian, thanks for being with us.

Ian: Thanks for having me, Greg.

Greg: First of all let’s begin at the top here and explain the purpose of due diligence in this context and the kinds of important things that can be discovered by taking the time to do it.

Ian: What we’re talking about here is if you’re looking to buying an asset or a company outright for merging into an existing enterprise or to run independently. Usually, these are very large purchases, and it’s important to know what you’re really getting in the deal. The due diligence, you can think of it as doing the research and the confirmation that you’re buying what you’re thinking of buying, that you’re not getting any liabilities or hidden costs or other kinds of things along with it that are negative that you don’t want. And that if there is anything out there, that you can bring it in and price it accordingly into the deal so you’re going in with eyes wide open and making sure that what you think you’re buying is what you’re getting.

Greg: Makes perfect sense.

Ian: You mentioned some of the things that you might look for, that you might be worried about. The thing that jumps to everyone’s mind are the finances, looking at the ledger, that everything has been done correctly as far as the accounting and things like that. But there are a lot of other elements and things you should be looking at [rather] than just dollars and cents when it comes to a business.

Greg: What are some of those other areas?

Ian: In addition to the financial due diligence, you’ve got legal due diligence, which ranges from things having to do with the real estate that might be involved with the acquisition to any other kinds of liens or judgements that might be out there against the company or any of the executives you might be hiring on as part of this acquisition. There’s IT due diligence now that technology is so important to what everyone does in the world today. Intellectual property due diligence, making sure that brand and the different copyrights and things like that, trademarks, that usually come along with certain businesses in the consumer sectors, is very important. You have reputational and regulatory due diligence that you need to be looked at, especially in the heightened regulatory environment we’ve been in for the last little bit. And you also have operational and commercial due diligence—making sure that things are running as smoothly as the person selling to you says it is. You wouldn’t buy a car without sending it to a mechanic, so you want to make sure the operations of a business are also running, and things like that.

Greg: Good analogies. So is due diligence “due diligence”, no matter what type of acquisition is going on? Or does it change a lot, or differ a lot, depending on what type of business we’re talking about?

Ian: There’s definitely a baseline of due diligence you want to do no matter what. Financial due diligence, legal due diligence are things you’ll always be looking at. But different kinds of businesses have different risks associated with them and different upsides. Depending on what industry you might be looking at, or different areas, or what your strategy is for why you’re buying this business or asset, you’re going look at a lot of different things. If there are a lot of properties associated, you’re buying something with a lot of offices or a lot of retail locations, obviously, you’re going to dig into the real estate side of things. If you’re buying something involving shipping, you’re going to have to look into boats, and boats have specific regulations and due diligence and things you should be looking at there. If you’re buying manufacturing facilities, there are lots of different elements that can come into play on the operational side, supply-chain-wise, health-and-safety-wise.

And in commercial due diligence, making sure there is no one key client that might be out there. If you have a business-to-business company—they’re looking at a wholesaler or something like that, where they manufacture something but Walmart is the only [company] that buys for them. What happens if Walmart decides to buy from somebody else? What’s the relationship like that’s making it happen? So there are a lot of different areas you’re going to want to look into that are specific to what you’re doing and why you’re buying them.

Same kind of thing with IP, if you’re buying something for the brand or for the underlying code of some software. We’ve seen this with how Apple sets up with their Irish structure where all of the IP sits over in Ireland and they kind of rent it back from that. If you’re buying a program or technology, and you think you’re getting the underlying patents for it, but really you’re buying a business that’s been manufacturing it and paying back to some other legal entity, and you’re not buying the actual patent itself, then you’re really not buying all the assets you think you are. So it’s really important to know what you’re buying and to have specialists in that area to help you. Obviously, your general lawyers for M&A will be able to help you with a lot of this. But if there is a lot of real estate or IP or other things like that involved, bringing specialist attorneys, specialist outside help can be really crucial in getting things done, especially in the timeline we have for deals these days.

Greg: Ian, we already talked about what due diligence is, why it’s really common sense in a situation like a merger or an acquisition to make sure you’ve got all your I’s dotted and t’s crossed, and why it’s very beneficial. But as you just explained, why you might need to make this happen, I can see some excuses flying into some folks' heads, that this could get expensive with lawyers and specialists and so forth, and maybe other reasons why some business leaders decide not to take the time for due diligence. What are some of those reasons, and what is your rebuttal to them?

Ian: It’s a buyer beware environment, right? If you want to buy a house without doing a home inspection, that’s your right. You can totally do that. House might fall apart in two years, you know, you’re buying a big money trap like the Tom Hanks movie. It’s really up to you and the risk you’re willing to take in a transaction. Everyone has to do the return on investment for everything that they do in any kind of business, right? If you do a background check on an employee or not. But what you’re looking at here are pretty large transactions. The larger and more complicated they are, the more you want to be bringing in these outside experts. And looking at what kind of risks bring liabilities into other aspects of your business. If you are buying a business that’s in the middle of some kind of litigation, and now all of a sudden you own this company, you could be party to that lawsuit. So instead of them being able to sue some smaller business that exists out there, now they can sue the smaller business and you for everything you had already built separately from this. That’s something you might want to take pretty seriously. It’s really about the weight of the risks, how much they impact not just the business you’re buying but your entire business, and really understanding how those things can spread.

Mind you, it isn’t always cheap to bring in lawyers and do these kinds of things, but the repercussions later can cost you a lot more.

Greg: So let’s go to the flip side. We talked about how not doing it is pretty foolhardy, but at the same time, how do you know you’ve done it thoroughly? Obviously, you hire people who’ve done this before, but every deal is a little bit different, and who knows where exactly you need to overturn some stones. How do you know you’ve looked at everything relevant to the proposed deal?

Ian: There is always another thing to look at, and another thing to get to, so that’s where pre-planning comes into effect a lot, and making sure that you know what your hot button items are, that you really need to be looking at early on so that you give that the time and effort that it needs, and figuring what are the risks and liabilities you’re willing to take on and continue on after the deal. Obviously, you don’t just buy a company, and everything is rainbows and sunshine. You have to integrate and move forward, and you have to have a strategy for the first hundred days. And a lot of that is continuing to dig deep and understand what you’ve bought and if there is anything else you need to be dealing with. So it’s really about prioritizing what you see as the biggest risks to you and your business and to the deal itself and getting those done early and spending the money on them upfront, and then saying, okay, what can we push to later if we need to? What can be partially done, what’s good enough look like for the deal to close, but that’s maybe not good enough for from now to the next hundred years of your business running?

Greg: Last questions before we let you run. Ian, I’m guessing that due diligence doesn’t end the moment you sign the deal.

Ian: Of course not. Nope. Think about it this way. You want to know everything about how your business is running right now. You ask your different sales and operations and HR group and all that to give you quarterly or annual reports on what’s going on, what the problems. And you can think of due diligence is doing that on someone who doesn’t work for you. But you’re going to keep on doing that deep dive once you’ve bought the company and that’s part of the integration process and ongoing good business practices to make sure you’re continuing to look at these things, understand what’s happening within your business, and that everything is running smoothly.

Greg: Ian, fantastic advice as always. Thanks very much for your time today.

Ian: Thanks so much.

Greg: Our guest this week, Ian Bone, Senior Manager of Strategy and Innovation at CT Corporation

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