Over the last several years, mergers and acquisitions have become increasingly popular. As common vehicles for raising capital, many companies see growth potential as attractive. (Read more about the growth potential mergers and acquisitions holds in this Bold story.) But all too often, various startups and even mature businesses rush into these deals without proper due diligence. Unfortunately, when this happens, weaknesses and gaps are not recognized early in the process. And the lack of effective oversight and review gives off a bad impression to potential buyers and investors. Ultimately, this can lead to a failed deal and a lot of wasted effort.
The importance to performing a thorough due diligence has always existed when contemplating mergers and acquisitions. But today, these efforts have expanded to include additional considerations. Certain company insights remain essential in this process, including financial, management, and process data reporting. But more modern aspects of a comprehensive due diligence now includes technology assessments and cybersecurity analyses. For businesses thinking about mergers and acquisitions today, not only must they be proactive in their company evaluations. They must also expand their perspectives to encompass a broader view of their potential.
”Sell-side due diligence is your chance to catch a red flag before an investor or potential buyer does. This is not to say that your company needs to be pristine, but if you miss key challenges on your end, it could jeopardize the deal, impact the valuation of your company, or result in monies held in escrow.” – Alex Castelli, Managing Partner of the Emerging Markets Industry Group, CohnReznick
Aligning Due Diligence Efforts with Company Stage
When it comes to mergers and acquisitions, different companies consider these strategies for different reasons. Some pursue these transactions in an effort to raise needed capital in an effort to scale their business. Others see these activities as a means to minimize the challenges of going public. Regardless of the reason, however, due diligence should be performed in every instance to increase the chances of success. But the extent and type of due diligence performed can vary with a company’s stage and its intentions.
To expand on this point, consider an early-stage company seeking venture capital support for continued growth. In these instances, those involved in mergers and acquisitions will want to clearly understand revenue models and customer pipelines. Due diligence metrics should include recurring and non-recurring revenues, margins, customer acquisition costs, and long-term value propositions. In contrast, late-stage companies who are about to go public, will need more extensive information reporting. In addition to the above, detailed information about decision-making and leadership choices will be required. Advisors and consultants are often helpful when conducting due diligence at this juncture.
The Importance of Tech Audits with Due Diligence
As technological advances have occurred, one of the important due diligence areas to consider involves tech audits. When thinking about mergers and acquisitions, it is important to evaluate existing IT infrastructures. Does existing hardware need to be replaced in the near future? How far advanced is the company’s digital transformation and are they modernized? (Read about the importance of digital transformation in the post-COVID world in this Bold story.) Is company information sharing efficient and provide strong business continuity? Each of these areas should be included in today’s due diligence efforts when mergers and acquisitions are being contemplated.
When a company merges with another, technology costs can be substantial if a coordinated plan is not in place. Unless a business performs a thorough tech audit with its due diligence, then the ease of this coordination remains unknown. Eventually, this information will be revealed before mergers and acquisitions are finalized. But being able to identify such issues early saves time and money for all. Plus, it can save companies a great deal of embarrassment along the way. For modern mergers and acquisitions, tech audits are essential part of the due diligence process.
“CISOs understand how a data breach can negatively impact the valuation and the underlying deal structure itself. Leaving cyber out of that risk picture may lead to not only brand and reputational risk, but also significant and unaccounted remediation costs.” – Deborah Golden, U.S. Cyber and Strategic Risk Leader, Deloitte Risk & Financial Advisory
Cybersecurity and Data Privacy Evaluations
In today’s world, the average cost of a data breach is roughly $4 million. Understanding this, it’s not wise to enter into mergers and acquisitions without due diligence in this area. Modern times demand that an assessment of existing cybersecurity practices be evaluated. Likewise, data privacy protections, data collection procedures, and general data practices must be researched thoroughly. This goes beyond a simple assessment as to whether a company is compliant with general cybersecurity regulations.
Beyond general compliance issues, due diligence efforts should assess a business within its specific contexts. For example, industry-specific cybersecurity practices may be standardized and require this in considering cybersecurity risks. Geographic locations, for example in the U.S. or Europe, can also affect company compliance assessments. And prior cybersecurity and data breaches must be revealed along with measures taken to mitigate future ones. Mergers and acquisitions might look great from a financial and growth perspective. But failure to appreciate cybersecurity risks can lead to an overestimation of value.
Upfront Efforts in Due Diligence Goes a Long Way
Resources are limited for any business, and this includes personnel time and effort. Before contemplating mergers and acquisitions, it’s therefore essential that comprehensive due diligence efforts be pursued. Not only does this make a company look more professional and organized. But it also helps identify issues ahead of time that can be proactively addressed. Thus, when an actual merger or acquisition inquiry takes place, weaknesses and shortcomings are minimized. By conducting such an audit in advance, while addressing modern concerns, companies will enjoy much greater success in their endeavors.
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