For companies trying to expand, break into new markets, or gain a competitive edge, mergers and acquisitions (M&A) can be game-changing. Whether it’s a merger or an acquisition, due diligence is a critical step in the process. Proper due diligence ensures that both parties understand the risks, obligations, and value of the deal before closing. Here’s a closer look at what should be considered during M&A due diligence.
Understand the Type of Transaction
Not all M&A deals are structured the same. Generally, there are three types of transactions: conglomerate, vertical, and horizontal. In a horizontal merger, both companies are in the same industry and may be competitors or operate in parallel markets. Vertical mergers involve companies at different stages of the supply chain, such as a manufacturer merging with a distributor, aimed at consolidating their position. A conglomerate merger happens between companies in unrelated industries, often to diversify business operations and manage risk.
Consider the Legal Structure of the Merger
The form of the transaction also affects due diligence. A statutory merger is common when the acquirer is larger and absorbs the target’s assets and liabilities, dissolving the target. In a subsidiary merger, the target becomes a separate entity owned by the acquirer. In a consolidation merger, both entities combine to form a new company. For instance, a statutory merger typically results in the automatic assumption of all liabilities, necessitating a careful legal analysis.
Review the Type of Acquisition: Stock vs. Asset Purchase
By purchasing shares directly from the target’s shareholders, the acquirer takes control of all known and unknown assets and liabilities. Although this approach protects the target’s contracts, it might subject the buyer to unanticipated liabilities.
On the other hand, an asset purchase gives the buyer the freedom to choose which assets to buy and only take on a limited number of liabilities. This structure is frequently chosen for lower-risk or distressed asset acquisitions because it provides better protection against unknown risks.
Understand the Motivation Behind the Deal
M&A deals happen for a variety of reasons. Some businesses look for agreements that will increase revenue or decrease expenses in order to create economic synergies. Others buy businesses to take advantage of tax breaks, generate year-round income, or enter new markets. Due diligence requires an understanding of these motivations since they affect future business plans, deal structure, and valuation.
Examine How the Deal Will Be Funded
The majority of M&A deals are financed by cash or a combination of cash and contractual commitments. Buyers need to carefully consider whether the payment plan makes sense financially, both now and down the road. During due diligence, the effects on operating budgets, debt commitments, and cash flow should all be examined.
Valuation Methods Matter
A core part of due diligence is determining whether the purchase price is fair. The acquiring company typically wants the lowest possible valuation, while the target seeks the highest. Valuation methods such as the Discounted Cash Flow (DCF) method, Comparable Company Analysis, and Comparable Transaction Analysis are commonly used. Understanding these methods—and ensuring assumptions are realistic—is key to avoiding overpayment or undervaluation.
Final Thoughts
M&A due diligence is more than just a checklist. It’s about deeply understanding the target business, the structure of the deal, and the strategic impact of the transaction. With the right analysis and professional guidance, companies can minimize risk, negotiate from a position of strength, and move forward make decisions.
