M&A Due Diligence Checklist: What Every Investor Must Read

When you're considering an acquisition, the excitement of a potential deal can work against the elbow grease that has to go on behind the scenes. That's when an exhaustive M&A due diligence checklist is your best friend. You're a private equity expert, corporate development executive, or business owner considering M&A opportunities. Regardless of what your title is, sound due diligence is what separates successful transactions from costly mistakes.

The statistics are grim: studies suggest that 70-90% of mergers and acquisitions fail to increase the buyer company's value. There are many reasons why this might happen, but inadequate due diligence is often listed as one of the main killjoys. You simply can't take shortcuts or rush the process—your money is at risk.

What Is an M&A Due Diligence Checklist?

An M&A due diligence checklist is your neatly scripted game plan for analyzing every aspect of a target acquisition opportunity. It is your investigative template upon which you can verify the facts, uncover risks, and assure the strategic rationale for the transaction.

This checklist serves a few functions in your M&A process. First, it ensures that you don't overlook critical areas that could influence deal value. Second, it organizes what otherwise can be a daunting amount of data. Finally, it creates a general framework that can be applied uniformly by your team on multiple deals.

Whether you are sell-side preparing for buyer inquiry or buy-side conducting due diligence on a target company, this merger and acquisition due diligence checklist will take you through the key areas that must be carefully screened. The most crucial thing is to be methodical—every item on your list is a possible risk or opportunity that can significantly impact the success of your transaction.

Financial Due Diligence

Your financial analysis is the backbone of any merger due diligence checklist. This is where you will spend considerable time checking the financial position of the target company and understanding the true economics of the business.

Historical Performance Analysis

Start with the company's audited financial reports for at least the previous three to five years. You will have to examine income statements, balance sheets, and cash flow statements for trends and anomalies. Be mindful of revenue recognition policies because aggressive accounting can skew performance numbers.

Don't just look at the top-line figures—pay for the quality of earnings. Are revenues recurring or one-offs? Is growth organic or acquisition-related? Wrapping your head around these nuances will help you make better estimates for the combined company.

Liabilities and Contingencies

Your checklist should encompass a thorough review of all debt obligations, such as bank loans, bonds, and off-balance-sheet financing structures. Carefully review debt covenants since they could constrain your operating flexibility after the deal.

Contingent liabilities require special scrutiny. They can include pending litigation, warranty obligations, or environmental cleanup costs not explicitly reflected on the balance sheet. These "hidden" liabilities can significantly impact your deal economics.

Financial Controls and Systems

Analyze the target's financial reporting processes and internal controls. Weak financial controls increase the likelihood of errors or fraud, whereas sound systems reflect credible financial reporting. This analysis is particularly critical if you intend to consolidate the target business into your existing operations.

Legal and Regulatory Due Diligence

Legal due diligence serves to prevent you from inheriting unexpected legal complications and ensures that the target is legally able to operate its business as claimed.

Corporate Governance Documents

Review the target company's articles of incorporation, bylaws, board resolutions, and shareholder agreements. These documents define ownership structure, voting rights, and any restrictions on transfer of ownership. You'll also want to verify that all corporate formalities have been duly maintained.

Include any drag-along or tag-along rights, anti-dilution provisions, or other shareholder protections that could affect your acquisition structure or future exit opportunities.

Contracts and Obligations

Look over all material contracts, including customer contracts, supplier contracts, employment contracts, and partnership contracts. Be aware of any change-of-control provisions that can activate your takeover—these can result in the termination of contracts or the requirement of customer/supplier approval.

Don't overlook smaller contracts that together can represent significant obligations. Service contracts, maintenance contracts, and licensing agreements can all add to your operating expenses and flexibility.

Legal Disputes and Compliance

Investigate any threatened or pending litigation, government regulatory investigations, or compliance issues. These problems can seem minor, but they can divert management resources and time post-acquisition.

Check whether the target company conforms to industry guidelines, environmental laws, and labor legislation. Regulatory violations can result in fines, operational restrictions, or reputation damage that affects business value.

Operational and Commercial Due Diligence

This portion of your merger acquisition due diligence checklist is interested in getting to know how the business actually operates and provides value to customers.

Business Model and Operations

Map the target's value chain from suppliers to end customers. Familiarize yourself with key operating metrics, capacity utilization, and bottlenecks to scalability. If the business relies on specialized operating expertise or proprietary protocols, assess how transferable such skills are.

Evaluate the competitive dynamics and the position of the target within them. Are there emerging threats or opportunities that could materially impact future performance? An understanding of these dynamics allows you to assess the sustainability of the target's competitive advantage.

IT Systems and Data Security

Technology infrastructure increasingly dominates operational efficiency and scalability. Review the target's IT systems, software licenses, and data administration processes. Out-of-date systems could require significant investment to integrate or modernize.

Data protection is of special importance in view of greater regulatory demands and cyber attacks. Review the target's cybersecurity practices, data privacy regulation compliance, and past record of security breaches.

Vendor and Customer Agreements

Review customer concentration risk—if one or two major customers account for a large portion of revenues, their loss might have an overly detrimental effect on business value. Examine customer contracts for renewal terms, rates, and any outstanding disputes.

On the seller side, look to dependence on key suppliers and examine supply chain risk. Single-supplier sellers or those doing business in unstable regions may be sources of operational risks.