Due Diligence: The KYC process in M&A

In business, the decisions are widely made on 2 bases – intuitive and informed. While intuitive decisions are key to many success stories, informed decisions are always safer and appropriate.

In M&A, the acquirer has few decisions to make. Whether to go ahead with acquisition? If yes, what is the value to be paid? And how to make payment? To answer these questions, information is required and that is what is gathered in Due Diligence.

Due Diligence majorly covers the following aspects:

Financial – The Financial records of the company are reviewed to understand the financial health of the company including the revenue, profitability and cash flow. The reviewed numbers are used for valuation of the business.  Arriving at the normalized EBITDA or determination of adequate working capital requirement are all crucial elements of the financial due diligence which could make a direct impact on the purchase consideration. 

Legal – The due diligence team inspect the compliance of the business with all required laws and regulation to ensure that there are no or major legal risks. For example, non-compliance with the Income Tax Act or Companies Act calls for a penalty even after 6 to 10 years after the commitment of non-compliance. Execution of proper Non-Disclosure and Non-Compete agreements with all the employees, proper and valid customer and vendor contracts, well documented HR policies in compliance with labor laws etc. are all relevant for smooth continuity of the business and helps in avoiding litigations in future. 

Operational – A smooth operational integration is the secret to successful M&A transactions. Thus, it is very important for the acquirer to understand the system and processes in place operationally. Understanding and ensuring that various departments run on the established systems and practices is crucial. For instance , keeping proper and periodic backup of the code repositories and project documentation is necessary for plain sailing of the business. Or having a sales engine with best business practices is required to make sure that there are customers coming in without failure. Operational due diligence covers these facets and ascertains that systems are in place. 

Technical – Evaluation of the technological infrastructure and technical skills of the team is necessary for the acquirer to understand how the acquisition would help them. Team is the raw material in tech business and only a good team can contribute to good profit margins. A good team is a balanced mix of various tech stacks, experience and expertise. No establishment can thrive with a few superstar resources and majority sub-standard ones. Having the right blend of team and technical knowhow is crucial for a fruitful M&A. Technical due diligence will give the acquirer a clear insight into the tech pool and the clientele technology.   

The mode of acquisition is decided based on the findings from the due diligence exercise. Depending on the nature of findings and severity of issues identified, the whole deal structure could be revisited. If Due Diligence asserts and confirms the initial claims made by the seller, it could be a confidence booster for the acquirer, else a deal breaker.