Due Diligence as a strategic necessity in M&A transactions
Due diligence has evolved from a simple validation process to a strategic tool which is necessary to ensure the long-term success of an M&A transaction. These days, not conducting an exhaustive assessment can expose companies to significant risks which have both financial and reputational impact.
Throughout the years, I have had the chance to advise companies on a wide range of M&A transactions, and one thing is clear: due diligence has evolved. In the past, it used to focus on financials, assets and legal agreements. While these issues remain essential, the process has extended significantly to also cover corporate social responsibility, reputation and sustainability matters.
In particular, EU legislation such as the GDPR and Corporate Sustainability Due Diligence Directive have reinforced the need to integrate these aspects into the due diligence. For example, under the GDPR, any data transfer in a transaction must fully comply with legislation in order to avoid penalties. This means that during the due diligence phase, the buyer must ensure that the target is fully compliant with data protection regulations. Not doing so may lead to fines which could significantly impact the final value of the deal.
However, ESG rules also present opportunities. We have seen how companies which adopt sustainable and socially responsible practices become more attractive for investors. These companies are not only less liable to facing reputational crises, but also tend to be more efficient and resilient.
The key layers of Due Diligence
Due diligence is a process which comprises different layers, each designed to mitigate a specific type of risk:
- Financial: This is the cornerstone of any due diligence process. It involves a review of financial statements, debts, contracts and any other information which offers a clear picture of the company´s financial health. In our experience, companies which provide precise and up-to-date financial reports do not only generate confidence, but can also obtain higher valuations.
- Legal: Reviewing contracts, ongoing disputes and IP is key to guaranteeing that there are no hidden risks. A contract with unfavourable clauses or unexpected litigation proceedings can dramatically impact the profitability of an acquisition.
- ESG and Compliance: In the current environment, sustainability and corporate compliance are not an add-on, but a necessity. As regulations become stricter, investors are increasingly aware of the associated risks. In particular, a proper assessment of corporate governance has become key. How are risks managed? Is there transparency in the decision-making process? These are the issues which can define the success or failure of a transaction.
The challenge of obtaining reliable data
One of the main challenges in the due diligence process is access to reliable data. The quality of information provided by the target company is key to making a precise assessment. A lack of standardisation in ESG reports is a common hurdle. Many companies still lack solid systems to measure and report their social and environmental impact, and this presents a challenge to investors who need to obtain a clear view.
In addition, in my experience, international transactions present additional challenges, such as local differences in legislation and a lack of transparency in certain markets. For this reason, having advisors who understand both the local and the global environment is essential.
The importance of being proactive about Due Diligence
I have learnt that the key to successfully completing a due diligence process is proactivity. It´s not just about flagging problems, but anticipating them. The most successful buyers and investors do not wait until unpleasant surprises spring up. They take a proactive approach, analysing not only the data provided, but also issues which may be overlooked.
A recent trend which I have observed is the integration of ESG and financial and legal due diligence teams. This not only speeds up the process, but also allows for a more holistic evaluation of the target company. Instead of analysing each area separately, this approach allows a clearer vision of how all these factors interact with each other to impact the final valuation.
Manuel Urrutia.