What is Due Diligence in M&A?

Due diligence is a critical part of mergers and acquisitions (M&A). What is due diligence, exactly, and how can companies strengthen their due diligence capabilities? 

Hearing M&A news is always interesting, and usually quite exciting. But what happens before a deal is inked? How can buyers be sure they’re making the right move?

Imagine your organization is interested in buying a founder-run business. You notice it has an unusually high amount of customer concentration—in other words, the top X number of customers account for an unusually large percentage of the company’s revenue. You also notice irregular trends in annual purchase history across these top customers. This is surprising because it differs from what you were originally told earlier in the process.

After doing further investigation, you realize most of their top customers are businesses owned by the founder’s family and close friends. After reviewing their purchase history in more detail, you realize these businesses are making purchases at greatly inflated prices. You know that under your ownership, this wouldn’t continue. You lose your sense of trust in the founder, so you walk away from the deal.

This scenario isn’t purely hypothetical—it’s something my team and I encountered (at a different organization than Progress) when working on a deal. This example perfectly illustrates the critical importance of due diligence.

So, what is due diligence? Simply put, it’s the comprehensive investigation a buyer undertakes after expressing interest in acquiring a company, before proceeding with the deal. This process enables a buyer to comprehensively assess a target company and to identify potential business and transactional risks, while validating the strategic rationale and underlying assumptions. Read on to learn more about due diligence and its importance in M&A.

What Does Due Diligence Entail?

With diligence, a buyer is looking to achieve three main objectives: validate their strategic rationale, identify items which could impact valuation and uncover red flags that might lead them to not proceed with the deal.

Diligence involves a technical review of the target company’s products, a thorough vetting of the company’s sales and go-to-market function and a detailed business review across all other major categories of business risk: including financial, legal, human resources, IT, and cybersecurity. The buyer typically works closely with the target company’s management team on these initiatives.

Building a Diligence Team

At Progress, we have multiple employees with subject matter expertise contributing to the success of the due diligence process, along with many outside advisors. Successful due diligence team members typically have great attention to detail, strong communication and problem-solving skills, a robust work ethic, and (above all) a love for doing deals.  

Due diligence team members review a significant amount of information over a very short period, so understanding how to prioritize requests and information review is vital. Communication skills are crucial for clearly discussing findings, while problem solving skills are necessary for identifying potential issues and for proposing viable risk mitigation strategies. Because most Progress employees working on due diligence remain accountable for their day jobs throughout the process, a strong work ethic and passion for deal work are essential. 

Why It Matters in M&A

Obviously, due diligence is crucial for a buyer because it helps identify risks (i.e. product technical shortcomings, legal issues, financial discrepancies, etc.). However, perhaps more importantly, the due diligence process helps buyers avoid unwanted surprises or challenges post-close, while helping to validate the deal thesis and dial in financial assumptions. Before we formally kick off the due diligence process, we spend a lot of time building the acquisition case and thinking through our post-close strategy. It’s always rewarding when the due diligence process confirms the acquisition’s strategic value and validates our original deal thesis.

The due diligence process also gives us an opportunity to better understand the company’s operations and workforce. This helps us alleviate integration challenges, while positively impacting employee retention and customer satisfaction post-close, leading to a more seamless integration. On a more qualitative level, we also spend time working to understand the target company’s culture. Reaching a point where we feel comfortable that the target is a cultural fit for Progress can greatly reduce the risk associated with our integration plan.

Challenges of Due Diligence

Asking the right questions at the right time is a difficult aspect of due diligence. The due diligence process would be a lot easier for buyers if we had an unlimited amount of time, could ask (and receive answers to) an infinite number of questions and had every piece of data. However, this isn’t the case.

One of the things we pride ourselves on at Progress is running an efficient and crisp diligence process. We only ask questions we need to know the answers to. We make data requests only if we believe the information could help inform our model or identify an issue that rises to the level of walking away from a deal. The Corporate Development team spends a lot of time encouraging the due diligence team members to be thoughtful with their requests. As an Acquirer of Choice, one way we differentiate ourselves from other buyers is by providing sellers with speed and certainty to close. We deliver that by focusing our efforts on key issues that drive our acquisition case.

What Makes a Buyer’s Due Diligence Capabilities Great?

Great due diligence capabilities start with a great team. If companies don’t have a comprehensive due diligence team roster, they should first assemble a motivated, multidisciplinary team comprised of experts across finance, product, engineering, legal, IT, human resources, sales, marketing, and other critical business functions. Companies should invest in training for these teams and should support their development, as it will enhance their ability to spot potential issues and to evaluate opportunities accurately. At Progress, we conduct M&A Seminars to educate folks on the due diligence process, purpose, and scope, with the goal of increasing the diligence team’s alignment when we’re in the heat of a deal. Progress also has a robust M&A Playbook that can always be used as a reference.

Additionally, companies should standardize their due diligence procedures, so they have an efficient, repeatable process for every due diligence. Before due diligence starts, companies should develop a list of key questions that they plan to answer during due diligence (this will confirm the deal thesis) and they should make sure their due diligence request list is inclusive of all required requests.

Teams should also leverage technology tools and software to drive efficiency and thoroughness in the process. Building an internal due diligence hub will give team members a place to collaborate and will encourage cross-functional communication, which is vital. Finally, learning from past acquisitions by conducting post-deal retrospectives can provide valuable insights that improve future due diligence efforts, allowing companies to refine their strategies and approaches continuously.

Most people think about M&A in terms of when a deal closes, but what happens before a transaction is announced is just as important. Without an effective due diligence process, buyers may not have the full picture of a target company, leaving them open to risk. Having a comprehensive due diligence plan in place, and executing with the right team, is a critical component of a successful M&A strategy.

Learn more about Progress’ M&A strategy and approach here.

This blog contains statements that are “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. Progress has identified some of these forward-looking statements with words like “believe,” “may,” “could,” “would,” “might,” “should,” “expect,” “intend,” “plan,” “target,” “anticipate” and “continue,” the negative of these words, other terms of similar meaning or the use of future dates.

Risks, uncertainties and other important factors that could cause actual results to differ from those expressed or implied in the forward looking statements include: uncertainties as to the effects of disruption from a transaction making it more difficult to maintain relationships with employees, licensees, other business partners or governmental entities; other business effects, including the effects of industry, economic or political conditions outside of Progress’s control; transaction costs; actual or contingent liabilities; uncertainties as to whether anticipated synergies of a transaction will be realized; and uncertainties as to whether a target’s business will be successfully integrated with Progress' business. For further information regarding risks and uncertainties associated with Progress' business, please refer to Progress' filings with the Securities and Exchange Commission, including its Annual Report on Form 10-K. Progress undertakes no obligation to update any forward-looking statements, which speak only as of the date of this press release.