date | theme

2 November 2020 | Merger of two corporations

25. January 2022 | Mergers & Acquisitions

17. March 2022 | Due diligence at a joint venture: 9 points to look out for

18. March 2022 | Due diligence on the acquisition of the company (this contribution)

Due diligence in the acquisition of a company is the basis for a successful corporate transaction. It should examine in advance to what extent the acquisition of a target company makes sense. Depending on the purpose and design of the planned company acquisition, very different aspects can come to the fore. For example, the requirements of a due diligence checklist for the purchase of a company are different when investing in a company specialized in research and development than in a manufacturing industry. Nevertheless, there are some points that are always of great importance in a due diligence for the company sale. This includes in particular the audit of finances, balance sheets, taxes and economic potential. After all, the primary purpose of due diligence is to identify potential future risks in a company purchase. Only then can the managing directors be sure that they have acted conscientiously.

Due diligence is an expression of a conscientious examination that found its way into the legal nomenclature in the USA in 1933. The introduction of this law (Securities Act of 1933) dates back to cases in which securities dealers should test the safety of the securities they market. When buying the securities, they had to check whether the companies behind them were actually worth the reported value. This was increasingly widespread in the USA, because there on the one hand since the end of the 19th century. In the 20th century, a wave of corporate consolidations took place. Smaller companies joined together into larger ones to compete in the increasingly competitive market. Incidentally, the term mergers and acquisitions originated from this period. On the other hand, the 1929 stock market crash on the New York Stock Exchange also had a share in this development. Many companies that had speculated and were now facing bankruptcy tried to find an investor.

The question was whether it was up to the seller to prove that the sale of his company did not involve any risks for the buyer, or whether a buyer, or his internal or external consultants, had a certain duty of care in the negotiations. Because if you buy a dilapidated company, for example, this also has an impact on your own shareholders. Since now the legislator also generally affirmed this responsibility of the buyer, this created an independent focus in negotiations, in particular on the company purchase. But also in other areas, due diligence has importance. For example, due diligence in a merger or joint venture of two companies also serves important, directly comparable purposes.

This brings us to the point of due diligence. In general, it consists in examining carefully whether and to what extent a project involving a foreign company constitutes an entrepreneurial risk. It is in the nature of things that very different aspects can be in the foreground. Without anticipating the next chapter, financial and economic aspects in particular come under the due diligence magnifying glass. In any case, a successful due diligence is characterized by a subsequent confirmation of the assessments in practice. This also includes explicitly the forecasts regarding the future development of the companies involved. But this can sometimes be quite delicate. Because sometimes success depends on details that are either easily overlooked or unpredictable. For the latter aspect, one can certainly count the current corona pandemic.

Although there may be many uncertainties, especially in the field of business combinations, it has turned out that certain points are always of particular importance in due diligence. Therefore, companies always create a due diligence checklist within the framework of mergers & acquisitions. These generally include the following nine points:

1st Compatibility audit

2nd financial audit

Macro Environment Analysis

Legal/environmental audit

5th marketing audit

6th Production audit

7th Management audit

Information systems audit

9th Reconciliation audit

Based on these previously defined points on the checklist, you then check whether certain candidates meet their own requirements. Occasionally, however, there are also requirements on the due diligence checklist that your own company has to fulfill if you want to crown the project with success.

However, since the circumstances of a project determine the content and focus of a due diligence examination, the due diligence checklist always represents a very individually composed examination regulations. Therefore, we want to include here only some of the most important points of a due diligence checklist for the company purchase in our considerations. In practice, however, our recommendation is that you put together a specialized team of lawyers, auditors and tax consultants, who will carry out the detailed development of a purposeful and targeted due diligence checklist. Of course, these experts should also carry out the due diligence examination on the basis of the checklist they have designed.

The first point need hardly be emphasized in its significance. After all, the finances of a company you want to buy are a very serious risk. Because with the purchase of a company via a share deal you also acquire its liabilities. So when buying a company, checking all financial aspects, but especially outstanding liabilities, is at the top of the due diligence checklist.

In an asset deal, however, this aspect may be less relevant. After all, you can exclude the liabilities from the acquisition and thus mitigate the risk. However, there are also dangers lurking here, which are equally relevant in a share deal. After all, the acquisition of economic goods should be worthwhile. If you want to buy a company, you should also evaluate their economic goods. If it turns out after the company purchase that the assets are not able to contribute to economic development because, for example, machines are obsolete or in need of maintenance, or patents expire, then of course this also has financial consequences for the own company.

The profitability of a target company naturally also plays an important role in the due diligence for the acquisition of companies. You can use the balance sheets for an in-depth examination to get an idea of the economic situation of a company. Furthermore, based on this data, one should be able to produce a forecast of economic development. But other factors may also play a role here. Some are only expressed indirectly in the balance sheets of a company. For example, if you want to acquire a company that is currently successful, but due to its products soon with a decline in demand, then this should also reveal a good due diligence to the company purchase.

Let us now mention some of the most relevant points in the examination of the books: