Mergers and acquisitions (M&As) have been around for a long time. But they don’t happen quickly or overnight. The acquiring company A always investigated, verifies, and audits the to-be acquired company B before the deal closes. Such “due diligence” enhances the quality of information available to the buyer A and provides them with an assurance of what they are getting by acquiring B. Without performing due diligence, the risks of a bad deal increase for A and the chances of success go down drastically.
This article explores the benefits of due diligence in M&A and uncovers the role of law partners in ensuring proper due diligence and a successful M&A deal. It also spotlights the role of automated document reviews using AI-based tools in speeding up due diligence and discovering risks that may remain undiscovered using manual reviews.
Why Due Diligence Matters in M&A
Due diligence is a crucial part of the M&A process, regardless of deal type, size, or participants. In many cases, due diligence is both expensive and slow – not to mention painful for transactional teams – but it still adds a lot of value to every transaction.
For one, proper due diligence where the team doesn’t take shortcuts can reveal many red flags about the acquired company. These red flags may be financial, operational, reputational, technological, or even human-related. Such defects could increase the purchaser’s risk and result in a bad transaction. The good news is that the discovery of these defects before the deal is finalised also gives the purchaser a solid reason to reconsider the deal or demand substantially different terms to go forward.
Due diligence also reveals material issues that could affect the deal’s price. For example, the auditors may discover a risk that could impact the buyer’s future income. Knowledge of this risk can help the purchaser to test the valuation model and even reduce the purchase price.
Detailed due diligence is essential to clarify any risks that the buyer might be willing to inherit, but only at the seller’s cost. For example, the buyer may seek an indemnity or escrow if they discover uninsured litigation.
Finally, due diligence is all about gathering important information about the target. Details about the target’s business model, sales practices, change of control provisions, culture, workforce distribution, etc. can help the buyer to learn more about the company they are acquiring and put controls in place to ensure a successful post-deal integration.
The Impact of Warranty and Indemnity Insurance on Due Diligence
Warranty and Indemnity (W&I) insurance is meant to insurance to cover any financial losses that may arise in a purchase agreement due to a breach of warranties or claims under certain indemnities given by the seller. However, the increasing use of W&I is driving change in due diligence processes by increasing the volumes that parties need to engage in. This is mainly because more insurers are asking for more comprehensive reviews in the deal before agreeing to underwrite it.
Any company involved in an M&A deal, especially on the buyer’s side, must understand and comply with the increased scope of review. They must also understand that the issues associated with any contracts that are not reviewed may be excluded from the W&I policy. Simply put, they must be aware of the consequences of not clarifying the scope of review and of taking shortcuts in order to save time and/or money.
The Role of Law Firms and Senior Partners in Due Diligence
In most law firms involved in M&A deals, due diligence is considered a low-value exercise to be done only by junior staff or associates. But the fact is – senior partners also play an important role in the entire process. In the beginning, partners must be involved in understanding the client’s business and M&A goals. They must talk to clients, guide them, and make suggestions about the different diligence approaches that can be adopted.
Partners should also be involved in guiding the team. They must be there to give advice and suggestions, and suggest ways to ensure that the work proceeds efficiently and in a timely manner. An experienced partner is also invaluable for problem-solving. They should weigh in on issues that will inevitable crop up, and ensure that the lines of communication are always open throughout the process, both with the team and with clients.
One or more partners must take ownership and accountability of the final due diligence report. They must review the report, confirm that it aligns with the client’s interests and requires, and ensure that it is communicated in the right way and format to the client.
And last but not least, partners should lead the way when it comes to technological transformation of the due diligence process. Manual reviews of a large number of contracts is time-consuming and painful for transaction teams. Errors are also common and may cause downstream problems for the client and even affect the outcomes of the M&A deal.
Partners should consider ways to automate contract reviews and speed up due diligence. They should be open to the fact that large-scale document reviews are only possible with technology like AI and AI-powered tools like Litera Kira.
Conclusion
Due diligence practices have evolved over the years. However, many still rely on manual reviews. Large M&A deals involving comprehensive due diligence require the review of tens of thousands or even millions of documents. Traditional, human-only processes are inadequate to meet these needs. The only way to review all the documents involved in an M&A deal quickly and with minimal pain to the transaction team is with AI-based document review tools.
Tools like Litera Kira speed up reviews and allow transaction teams to discover more risks that they might miss via manual processes. Thanks to automation and AI, they don’t have to limit the scope of due diligence to accelerate the deal. If anything, they can perform due diligence that is both more comprehensive and faster, and likely to lead to better deal outcomes for all parties.
