Due Diligence is a key component of any acquisition or merger.

What is due diligence?

Due diligence is the process of going through an examination and investigation in order to determine if the business or organization meets expectations. In other words, whether you are a buyer or a seller of a business, expect to go through due diligence. The term due diligence describes a general duty to exercise care in any transaction. Expect that within due diligence all aspects of the past, present, and future of the target company will be examined.

Reasons for due diligence:

· Confirmation that the business is what it appears to be

· Identify potential defects in the business

· Gain information that will be useful for valuing the company, defining representations and warranties, and/or negotiating price concessions

Who Conducts due diligence?

Lead and co-investors, corporate development staff, attorneys, accountants, investment bankers, loan officers and other professionals involved in a transaction may have a need or an obligation to conduct independent due diligence. Management typically assists these parties in obtaining due diligence information and groups like Ekinix can help.

What about confidentiality during due diligence?

It is always important to understand each parties' incentives and behavior during due diligence. Trust of course is something that needs to be built over time. At the same time, each company needs to cover themselves legally with nondisclosure agreements, non-circumvention agreements and other legal documents to ensure that each company acts appropriately, and has legal coverage.

When is due diligence Conducted?

Make no mistake, due diligence starts with the first interaction. This is why both parties need to be very careful about what they say and communicate from the beginning. Due diligence is typically conducted after the parties have agreed that a deal should be pursued and after a preliminary understanding has been reached, but prior to the signing of a contract.

Can a lawsuit develop from inadequate due diligence?

In the United States, anyone can sue anyone else with even slight cost. We live in a litigious society certainly. However, if each party acts in good faith, generally lawsuits can be avoided or at least thrown out in the event the other party sues your firm.

How is due diligence Conducted?

Usually the acquiring company develops a checklist of information they require in order to conduct due diligence. In most cases, the acquiring, or surviving company will run the process. However, management does have the right to refuse certain documents that are requested before they are necessary. For instance, if in the first conversation the acquiring company asks for detailed financials, management should resist that until both companies are closer to an agreement.

Once this is done, management of the target company may be asked to produce financial statements, business plans, customer lists and other documents. In addition, interviews and site visits are will become part of the process. Also, research is conducted with external sources -- including customers, trade organizations, vendors, industry experts and others.

What is the extent of due diligence?

The amount of due diligence will be dictated by a combination of the acquirer's interests, and management's willingness to give information. If a merger or acquisition is advanced, eventually all aspects of the business should be revealed. One of the most important and final sets of documents would be bank statements for all accounts. The reason for this is that bank statements are the end result, in other words no matter how you account for things, bank statements show cash in and cash out. As a result, they should not be revealed until the time is right. An acquiring company can never truly reduce all of its risk through due diligence, but they certainly can reduce enough risk to make a decision on the right acquisition cost.

Can due diligence be overdone?

Certainly. As stated above if a company feels that the acquiring entity is asking for too much information too quickly, they can walk away from the deal. In many cases acquisitions happen based on a company wanting to acquire market share via buying one of their competitors. It makes sense for the acquiring company to be very careful about what they reveal until they are completely covered through non-disclosures, non-circumvention agreements and other documents, as well as having an overall feeling that the competitive company is operating with the right attitude. However, there have been many accusations of competing companies going through the process and learning all about their competitors.

At the same time, the acquiring company needs to be very flexible and provide the right information at the right time.

How much time should be allowed for due diligence?

There is no set time frame because each transaction is different. Due diligence is an ongoing negotiation where each side continually gages the other side's interests and behaviors. If one side feels that the negotiations are taking too long, then they will press the other side for more information or to move more quickly. Many deals fall apart because one side wants to move more quickly than the other.

What are the costs of due diligence?

Since each transaction is different, there is no way to determine a fixed cost for due diligence. Costs can run from a few thousand dollars into millions of dollars, especially as legal teams are assembled. There are also opportunity costs which in many cases are not calculated. These include management and staff hours spent in meetings and research.

Generally, each side takes responsibility for due diligence costs.