Due diligence: importance, process, types and costs [incl. checklist].
Due diligence occupies a special position in the entire M&A process. It represents a comprehensive company audit, the outcome of which has a decisive influence on the further course of the negotiations. Although it alone does not guarantee the success of an Company sale can guarantee, it is nevertheless an important basis. So it is not surprising that it is usually given a lot of attention.
This article explains both the formal meaning and Objective of the due diligence as well as the Procedure in practice. Last but not least, we provide an overview of the various Types of due diligence and provide guidance for Time and Costs, and the Scope in the form of a due diligence checklist.
What is due diligence?
Due diligence is a thorough examination of all relevant areas when you are making a Sell company want. It serves to verify the information on which the previous interest was based, but which was not checked. Among other areas, the focus is usually on legal, tax and economic aspects.
What does due diligence mean in German?
The English term 'due diligence' is also used in this form in German-speaking countries, but can also be translated as 'due diligence' or 'duty of care'. It is also easier to use the phrase 'due diligence' in a conversation.careful examination? use.
What is the aim of a due diligence audit?In principle, each due diligence can have an individual focus. The idea of due diligence is not limited to specific areas. However, the overriding goal is always to determine and ideally limit the opportunities and risks of an M&A transaction. This information is important in deciding whether a purchase or sale can take place at all or on what terms the Company purchase agreement is possible.
What is being tested?There are no restrictions as to which documents can be consulted in the course of a due diligence review. In the usual case, the buyer and his
Where in the sales process does it take place?Typically, due diligence is carried out following the signing of the 'Letter of Intent'. initiated. The LoI represents a milestone in the M&A process which expresses the clear interest of both parties. On this basis of trust, the sensitive documents can be released for inspection. This means that due diligence is carried out early on in the process to provide a basis for the subsequent negotiations.
Who carries them out?
Although both the buyer and the seller can initiate a due diligence process, it is usually the potential buyerswho carries it out. On the one hand, this is a question of trust: Does an audit carried out by the seller also reveal all the risks? On the other hand, the buyer's interest in the audit is greater; after all, the seller already has all the information about the company.
While the buyer initiates the due diligence, he hardly carries it out independently from an operational point of view. Depending on the individual M&A case, a team of specialists will be required to expertly review all documents. This means that lawyers, tax advisors and also M&A consultants will be involved.
Due Diligence Process
While individual examination patterns can be used depending on the individual case, a 5-step model for the examination process has become established in practice.
After clarifying the objectives and focal points, a preliminary research is carried out by the appointed experts. This preliminary research provides an overview of important sub-aspects and special audit needs. This is followed by an examination of the individual sub-areas, which culminates in a compilation of the results. The presentation often takes the form of clear models, such as the SWOT analysis model (strengths, weaknesses, opportunities, threats). Recommendations for further action are derived from these results.
Due Diligence Checklist
If you would like to know which points are checked in detail, we recommend that you take a look at our Due Diligence Checklist to throw.
What are the different types of due diligence?
Due to the different focal points of a due diligence audit, individual forms of due diligence have become established in practice. Although they basically follow similar patterns, they differ in detail.
Tax Due Diligence (TDD)
The tax review examines the tax situation of the target company and its relevant tax influencing factors and risk factors. The TDD structures the Company sale procedure better in the end. In particular, it is important to structure the purchase of a company in such a way that the purchase price can be written off and the financing can be tax-efficient.
Financial Due Diligence (FDD)
The FDD validates the data used in the Business valuation and analyses the financial opportunities and risks of the target company. This includes determining the sustainably achievable earnings, evaluating cash flows as well as balance sheets and annual financial statements and checking the plausibility of the business plan.
Legal Due Diligence (LDD)
LDD therefore reviews all legal aspects with internal and external contractual partners of the company for legal risks and pending legal disputes. For example, existing tenancy and lease agreements, employee contracts, procurement and supply contracts or, for example, copyright, labour law and antitrust aspects are subject to review.
Environmental Due Diligence (EDD)
The EDD examines the environmental quality of the company, its facilities and buildings. For example, it examines the pollution or contaminated sites from previous industrial or technical use with which the company is confronted. In addition, the site is assessed with regard to future protection status (such as bird sanctuaries, etc.). Finally, building pollutants (e.g. asbestos in the properties) are surveyed, which can cause additional costs in the event of demolition or conversion work. Increasingly, energy efficiency is becoming an important part of the EDD. This area is usually dealt with in conjunction with technical due diligence.
Commercial Due Diligence (CDD)
The CDD examines the sales markets for market shares, segmentation, growth and competitive situation. In addition, the strengths and weaknesses of the company are examined. Commercial due diligence is used more for larger transactions. In smaller transactions, the acquirer obtains an overview of the issues examined in this analysis during the preparation of the business plan.
Real Estate Due Diligence (IDD)
The IDD examines ownership and rental relationships with regard to real estate that is either used for the operation of the company or is merely counted as an asset. Condition, obligations or long-term perspectives of the real estate are only selected points that are examined here.
IT Due Diligence (ITDD)
Due to the increasing digitalisation of many business areas, the examination of information technology is becoming more important. IT due diligence examines the IT quality and security as well as the future security of a company.
Technical Due Diligence (TDD)
The TDD examines the technical condition of facilities and buildings. The aim is to evaluate the technical facilities and buildings and to work out repair and modernisation potentials. This analysis reveals hidden investment backlogs.
HR Due Diligence (HR DD)
Human resources due diligence is a form of due diligence that involves a strategic and careful examination, evaluation and analysis of a company's human resources. The focus here is on management structures, management processes, human resources instruments and systems as well as the corporate culture.
Red Flag Due Diligence (RF DD)
A red flag is a situation that can jeopardise the entire M&A process. The corresponding due diligence specifically examines obstacles to the further course of the talks. These can be, for example, a problematic financial situation or obvious errors in the documents submitted.
Vendor Due Diligence (VDD)
At the Vendor Due Diligence it is the seller who proactively commissions the audit. An independent third party is commissioned (only then is this VDD sustainable). The results are presented to the potential buyer along with all other relevant documentation. This can speed up the process and provide confidence.
How long does it last?Due to the different demands on the company audit, the duration cannot be quantified with a generally applicable flat rate. However, experience shows that a period of up to six months is possible. Of course, periods of one or two months also occur with smaller purchase objects, but a duration of three months should be taken into account even with optimistic planning.
What are the costs?
Based on the information provided so far, it is evident that no reliable estimate can be made for the costs of a complete due diligence. The size of the transaction object, the demands on the scope of the due diligence and the number of experts involved all have a considerable influence on the final costs. As a non-binding guide, which may only be regarded as a rough estimate, a rule of thumb can be used: The costs of due diligence are between 2 and 5 % of the total transaction amount, depending on the sale price of a company.