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Mergers and Acquisitions Due Diligence: A Comprehensive Overview

handshake after successful merger and acquisition

In recent months, our conversations with sale leaseback clients, vendors, and other counterparties to our transactions seem aligned in one thing: Mergers and acquisitions (M&A) are on the rise. This sentiment is based on an over 30% global increase in Q1 2024 versus Q1 2023. With a total transaction volume of roughly $755 billion, “mega transactions” worth more than $10 billion nearly tripled, to 14 from five. These deals represent significant strategic initiatives for companies seeking to expand, consolidate, or diversify their operations. Central to the success of these transactions is the process of due diligence—a systematic investigation and analysis of the target company's assets, liabilities, financial performance, and potential risks. In this month’s article, we will provide a comprehensive overview of M&A due diligence, highlighting its key components, challenges, and best practices.  

Understanding M&A Due Diligence

M&A due diligence is a critical phase in the transaction lifecycle, spanning pre-deal negotiations to post-closing integration. Its primary objective is to provide the acquiring company with a thorough understanding of the target's business operations, financial health, legal compliance, and strategic fit. By conducting due diligence, acquirers can identify opportunities, assess risks, negotiate favorable terms, and make informed decisions about the transaction. 

Key Components of Due Diligence 
  1. Financial Due Diligence: Financial due diligence involves examining the target company's historical financial statements, forecasts, cash flows, and key performance indicators (KPIs). Analysts assess revenue streams, cost structures, working capital management, and capital expenditure requirements to evaluate the target's financial health, profitability, and growth prospects. 

  2. Legal Due Diligence: Legal due diligence focuses on identifying and assessing the target company's legal and regulatory compliance, contractual obligations, litigation risks, intellectual property rights, and corporate governance practices. Legal experts review contracts, licenses, permits, litigation records, and regulatory filings to uncover potential liabilities and legal issues that may impact the transaction. 

  3. Operational Due Diligence: Operational due diligence entails evaluating the target company's operational capabilities, production processes, supply chain management, technology infrastructure, and human resources practices. Analysts identify operational inefficiencies, scalability constraints, synergies, and integration challenges to assess the target's operational viability and alignment with the acquirer's strategic objectives. 

  4. Commercial Due Diligence: Commercial due diligence involves analyzing the target company's market position, competitive landscape, customer relationships, branding strategies, and product/service offerings. Market research, customer surveys, competitor analysis, and industry benchmarks help assess market dynamics, growth opportunities, and potential risks affecting the target's commercial viability and long-term success. 

  5. Real Estate Due Diligence: Focuses on evaluating the real estate aspects of the target company. This involves assessing the quality, condition, ownership, and associated risks of its real estate holdings. Key components of this phase include: reviewing lease agreements and rental income terms for real estate properties; performing environmental site assessments to identify any hazardous materials or compliance issues; inspecting the condition and operational status of facilities and infrastructure; and reviewing liabilities such as mortgages, liens, taxes, and maintenance agreements to assess financial obligations. This thorough assessment ensures the acquiring party gains a comprehensive understanding of the target's asset portfolio and any related liabilities.  
Challenges and Best Practices

Despite its importance, M&A due diligence poses several challenges, including data access, time constraints, and cultural differences. To overcome these challenges, acquirers should adopt best practices such as: 

  • Establishing a multidisciplinary due diligence team comprising financial, legal, operational, and industry experts. The Ascension Advisory team is proud to be considered one of these experts for those firms looking to execute a sale leaseback simultaneously in an M&A transaction. 

  • Developing a detailed due diligence checklist and timeline to ensure comprehensive coverage and timely completion. 

  • Leveraging technology and data analytics tools to streamline data collection, analysis, and reporting processes. 

  • Conducting on-site visits, management interviews, and customer/supplier meetings to validate information and gain insights into the target's operations and culture. 

  • Engaging in open communication and collaboration with the target company's management, advisors, and stakeholders to address concerns, negotiate terms, and facilitate a smooth transition post-closing. 
Incorporating Sale Leaseback into Your Due Diligence Process

When considering an acquisition, the real estate component of the target company can be strategically converted into equity, bolstering your capital stack. There are two key factors to consider in your analysis: 

  1. Equity Reduction: By leveraging the real estate, you can reduce the equity check required at closing. The sale leaseback also presents an opportunity for arbitrage, allowing you to extract additional value from the real estate beyond the seller's asking price. To delve deeper into arbitrage and value creation, explore our previous article, "The Art of the Free Roll Sale Leaseback Edition."

  2. Rent Adjustment: Incorporating the new rental agreement, including escalators, into your forward-looking financial model is essential. This adjustment will directly impact your operational activities, underscoring the importance of its inclusion in your due diligence process. 

M&A due diligence is the critical phase in a transaction process that requires thorough analysis, strategic insight, and collaboration across functional areas. By conducting comprehensive due diligence, acquirers can mitigate risks, uncover value drivers, and maximize the success of their M&A transactions in an increasingly competitive and dynamic business environment. 

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