I was a panelist at the recent Digital Hollywood conference. The topic was Venture Funding, Investment and Mergers. One question made me really think. In the context of a busted deal, we were asked how to head off surprise issues which can crater a potential company sale. The answer is to do your (generally extensive) due diligence both thoroughly and as quickly as possible.
But how exactly does company’s management go about doing that diligence?
Again, an easy answer does exist: hire the right investment bankers, lawyers and perhaps accountants. Sometimes a private investigator is also hired. But that answer only gets someone part way. Because ultimately management will live with the results of that diligence and therefore must stay involved, or appoint someone senior from the company to fill that role.
So what does doing your due diligence entail?
On a typical M&A transaction the bankers or lawyers representing the seller will put together a data room based on an extensive list of documents. We’ll then set up conference calls between the relevant parties to discuss questions that aren’t covered within the documents provided, or that stem from them.
Confidentiality of information is always an issue; even if an NDA is in place. Anything too proprietary must be kept confidential (and can be covered in any purchase or other agreement) and information is typically provided on a need to know basis. Sometimes it can also be disclosed to a company’s lawyers or accountants but not directly to management. Such sensitive information includes: technology, customer information, product sales mix and employee information. Indeed, some contracts may also limit what information can be shared with third parties.
On the disclosure side most bankers (and lawyers!) will encourage their clients to disclose any potential “smoking guns” upfront. If you have an issue which may scuttle the deal better to let the party know before you open the kimono, give them more information and ultimately waste everyone’s time. Either they can accept the information and move forward or not. And, nothing undermines credibility more than such an issue being discovered by the other party later in the process (which can scuttle the deal and possibility lead to a lawsuit).
Experts can also be brought in to do the diligence in niche, specialized areas like technology, industry or product.
What general topic areas are covered in the diligence process? Each list of items is customized for the respective company and its industry. Generally, the basics include: financials (audited, if possible) going back five years, customer and sales information, product information, facilities, legal information, general corporate information (such as articles of incorporation, board minutes, etc), marketing, employee information, retirement and health plans, environmental information, patents or other technology-related information and more.
Due diligence is a process that must be done thoroughly and with care. Missing something important can be a very costly mistake. In the long run, hiring experts when necessary is a wise financial decision.
Megan Jones is Director at Hadley Partners Incorporated. Ms. Jones has been advising start-up and more established companies for 19 years. Her expertise includes mergers and acquisitions, restructurings, divestitures, strategic partnerships and capital raising. She has also consulted with private equity and venture capital firms and hedge funds. Her current focus is on digital media, high-tech and Internet-related industries, in particular on identifying emerging trends and technological or market shifts. Prior to joining Hadley Partners she worked for Needham & Company, Merrill Lynch, Lazard Freres and Ernst and Young. Ms. Jones' novel, Captive, is being released in October 2010. Megan's blog is at http://www.hadleypartners.com/InReelTime.