The Importance of Due Diligence & Directors' Duties
Posted 16 May 16 by Steve Perri
In recent years we have seen improvement in corporate confidence in Australia which has resulted in an increased level of merger and acquisition (M&A) activity. There are many reasons for businesses to expand through acquisition, including differentiating or diversifying products and the pursuit of cost synergies or scale efficiencies. However in order for acquirers to fully realise the benefits of any potential acquisition it is imperative that an adequate due diligence process is undertaken.
The importance of executing adequate due diligence is arguably underpinned by directors statutory and fiduciary duties. The Corporations Act 2001 (Cth) requires directors to exercise their powers and discharge their duties with the degree of care and diligence that a reasonable person would exercise. To discharge this duty in the context of a business transaction involves identifying and evaluating risk to ensure the commercial potential of an acquisition opportunity is appropriately scrutinised before a deal is executed.
Conducting an adequate due diligence process may require the vigorous review of many facets of a target business some of which are best undertaken by an experienced external professional. An external consultant may bring technical skills, industry experience and knowledge gained from prior deals and due diligence engagements focused on mitigating an acquirer’s risk. The financial statements of a business often receive great attention when assessing a potential business acquisition, however this underestimates the significance of other factors within the business that are not necessarily apparent in the financial statements. Some questions to consider include:
Intellectual property and technology - Are confidentiality agreements, trademarks and patents in place to protect the value of intangibles and are they owned by the target business? Situations where value of the target is represented by intangibles that may not be owned or adequately protected represent risk which if unidentified and mitigated may erode value to the acquirer.
Customers – Does the target’s customer base include a large level of concentration? Does any exposure to warranty claims exist on prior sales?
Management and employees – Does the target rely on key personal? Is the acquirer able to retain them or have the capacity to replace key employees? Are adequate restraints contained in existing employee contracts?
Strategic fit – Does the culture of the target reflect the acquirers’ core values?
Synergies – What synergistic benefits does the buyer expect to achieve through the acquisition?
Unfortunately, too many businesses do not end up realising the synergistic benefits identified during the due diligence process. This often occurs due to the acquirer overestimating the synergies the merger or acquisition will yield. It is therefore imperative that the allocation of resources is sufficient during the due diligence process to appropriately review and challenge the assumptions used when valuing synergistic benefits. An appropriate integration strategy post completion, to ensure synergies are realised, will also assist in ensuring synergies are maximised.
Material contracts – Are any material customer or supplier contracts due for renewal in the near future? Has the target made any commitments that will need to be fulfilled?
Legal – Is there any pending or potential legal matters? Have there been any recent legal issues that may give rise to reputational damage to our existing business?
Due diligence is an important process that can often be subject to budgetary and timing constrains. Making sure you take the appropriate time to run an adequate due diligence process will not only ensure you carry out your duties as required under the Corporations Act 2001 (Cth), it will ensure you are in the best position to make an informed decision as to whether a potential acquisition is worth pursuing.