Adapting to the ‘new normal’: best practices in M&A due diligence

June 2022  |  FEATURE | MERGERS & ACQUISITIONS

Financier Worldwide Magazine

June 2022 Issue

As a wealth of transactions recorded over the last 12-18 months can testify, the coronavirus (COVID-19) pandemic had not slowed the M&A juggernaut – at least not until the additional shock waves of Russia’s war on Ukraine. In 2021, records were broken in terms of total deal value, with $5.9 trillion worth of announced transactions, according to Bain & Company’s 2021 M&A Report.

And yet, at the same time, deal processes and due diligence practices were greatly affected by the ‘new normal’ imposed by COVID-19 conditions. Dealmakers had to reexamine best practices in due diligence, taking in technology, remote analysis techniques, forecasts and accounting in light of economic upheaval, M&A insurance trends, environmental, social and governance (ESG) issues, and other considerations, to close transactions virtually, efficiently and successfully. The pandemic extended and complicated the due diligence phase, with additional lines of inquiry needed to adequately examine a target company and its business activities.

Lockdown challenges

Government responses to the COVID-19 crisis had tangible implications for traditional dealmaking practices. Borders were closed, travel restricted, and face-to-face meetings were no longer an option. In the short term, many companies were focused primarily on keeping the lights on rather than chasing acquisitions. But when dealmaking did return to the corporate agenda, process changes were needed to adapt to the ‘new normal’ – some of which may outlast the pandemic.

At the height the pandemic, one of the most striking effects on the M&A process was the restricted ability to physically visit target companies. For some transactions, carrying out due diligence on the ground, walking the site and interacting with employees, may be essential to building a deep, clear and accurate picture of the company.

Economic uncertainty caused by the pandemic also increased the emphasis on due diligence. Gathering pertinent information to assess risk in the target’s supply chain, for example, or to project the effect of the crisis on future revenue, has been incredibly important. New areas of due diligence focus have also come to light in the COVID-19 era, such as checking for any irregularities in how the target handled government loans or furloughed employees.

Turning to tech

Technology played a vital part in enabling M&A to carry on through the pandemic. Videoconferencing software, such as Zoom and Microsoft Teams, quickly became vital platforms allowing meetings to take place virtually. The relative ease with which parties migrated to online communication suggests these tools will be used going forward – particularly as ESG concerns mount and companies are under pressure to reduce their carbon footprint.

Shareholders and other stakeholders increasingly expect senior management to give thought to sustainability, to actively contribute to global environmental goals, and to act in a socially responsible manner. Remote M&A due diligence can have a positive impact on efforts to improve ESG performance by reducing travel for site visits, which may instead be conducted via video calls.

According to a report from Dataset, new technologies will continue to support the acceleration of due diligence processes. Sixty-seven percent of firms surveyed believe that by 2025 the M&A process at their company will have hit a high level of digital maturity and technological sophistication.

Tarifa Simpson, a partner at Mazars, believes that remote working and other changes to due diligence will persist beyond the pandemic. “Due diligence has evolved from physical data rooms and weeks on site, to virtual data rooms and conferencing tools, to the suite of remote tools used today,” she says. “From personal experience, there was some initial concern around virtual dealmaking – from client introduction, to pitching, delivery, feedback and completion. Once the proof of concept was there, the degree of confidence rose across the deal community.

“This timed well with an increase in deal volumes, which put a great amount of pressure on due diligence providers. The ability to remove some of the time lost to travel or unproductive audio calls was welcomed and provided some headroom to run projects in parallel,” she adds.

Embracing VDRs

Key technology developments include the use of virtual data rooms (VDR) with artificial intelligence (AI) and machine learning (ML) technologies, to upload, review and synthesise large amounts of data more efficiently. Using data rooms to verify and assess financial records and other key documents has been an essential part of dealmaking. The migration to online versions of data rooms is nothing new, but has certainly been boosted by COVID-19.

Due to their advanced analytics capabilities, VDRs support the workflow that allows the due diligence process to become faster and more efficient. Furthermore, AI and ML capabilities can help VDRs significantly speed up due diligence by automating repetitive and time-consuming tasks, such as multilingual search capabilities, risk and compliance reviews and contract analysis, thereby freeing individuals from being caught up in endless streams of data.

AI and ML also improve workflow accuracy and efficiency by automatically sorting, assessing and classifying thousands of documents in minutes, transforming the due diligence process into a more proactive, data-driven operation. Data analytics can provide vital insights during the research stage of due diligence, sifting through and categorising contracts, indexing their content for search purposes, and reporting on the security protocols of a target business.

Advanced Q&A features offered on a VDR platform can, for example, streamline communication between buyer and seller, increasing collaboration and strengthening the relationship. Companies often used online data rooms to share important documents and files, and this practices has only increased over the last two and a half years.

While VDRs offer many advantages, there are risks to consider, most notably around cyber security and data protection. Given the nature of documents reviewed in the due diligence process, including financial statements, cap tables, lists of shareholders, intellectual property (IP), and employee and management agreements, for example, cyber security is of paramount importance. Should sensitive documents fall into the wrong hands, it could derail the deal entirely. If a rival company gained unauthorised access, the information could be used to undermine the target or leverage a competitive advantage.

To combat this, VDRs also grant increased data protection and access control features, making it safer to exchange confidential information in a structured way, including redacting or blacklining where necessary. Additional security features, such as two-factor authentication, can further reduce the risk of cyber breaches.

A ‘hybrid’ approach to due diligence

In the post-COVID-19 landscape, as we are already beginning to see, the human touch will return to M&A. In-person meetings, conferences and site visits will remain a part of dealmaking due to the insights they can deliver which may not be gleaned on a video call.

“The efficiency brought about by remote working is here to stay, to a degree,” suggests Jon Stubbings, a partner at Grant Thornton UK LLP. “COVID-19 rapidly accelerated a trend that has been occurring over many years and converted many to the benefits of a hybrid working approach.

“However, one must not lose sight of the necessity of face-to-face interaction and on-site practical experience as part of due diligence – financial or otherwise – in really getting to understand a business,” he adds. “While I believe we will return to more on-site or face to face interaction than we have seen over the past two years, the current hybrid way of working and the benefits it brings are here to stay.”

At the same time, however, the COVID-19 crisis has demonstrated that M&A due diligence processes cannot remain rooted in the past. In cross-border M&A deals, for example, which otherwise may involve extensive international travel, the pandemic has necessitated an uptick in the use of new technologies to help facilitate remote acquisitions.

“We anticipate that, similar to other industries, the flexibility afforded by remote working is here to stay even for due diligence professionals,” says Preeti Inchody, a managing director at Ankura. “We will see the emergence of a new normal in hybrid working models, where due diligence professionals will have a few in-person meetings with clients to build closer relationships with the client stakeholders in addition to all the analytical work being performed remotely.

“Through the COVID-19 period, the relationship side of engagements has purely been through Microsoft Teams and Zoom calls for due diligence professionals, and there will be a push to start having in-person meetings with clients to strengthen the relationship side of engagements,” she continues. “Delivery of work and meeting deadlines were in no way hampered by remote working, as due diligence assignments are efficiently supported by technology, such as online data rooms, data analytics, search tools and, of course, online tools for communication and regular check-ins, such as Teams and Zoom.”

According to Ms Simpson, while there remains a place for site visits and in-person meetings, today’s technology has enabled all diligence providers on a transaction to achieve greater efficiency. “It has also improved the way that cross-border deals are carried out, mirroring the nature of the companies that are transacting and the investor base,” she says. “Due diligence professionals will look to use in-person interactions to build relationships around deal activity.”

M&A continues to evolve and the market is different today compared to 10 years ago. Executives and companies must keep pace with the shifting dealmaking landscape, particularly with respect to due diligence, where expectations are growing around new subjects. Poorly executed due diligence can easily unravel the benefits of pursuing a deal.

It is unlikely that acquirers will rely exclusively on virtual technologies to conduct due diligence and complete deals in the post-pandemic era; a hybrid of remote and in-person meetings is a more likely outcome. As M&A professionals lean more heavily on collaborative digital tools, they will need to utilise technology that maximises regulatory compliance and reduces risk around data privacy breaches during the due diligence process.

“Due diligence professionals have adapted to the changes very well,” says Ms Inchody. “Apart from the client relationship aspect of engagements, the internal dynamics of the team are better facilitated in a hybrid model where team members, especially junior team members, will have the opportunity to learn on the job sitting alongside more senior staff while working on client deliverables. But this is the case in many industries, until knowledge transfer structures emerge which back a 100 percent remote working model.”

“Professionals, and particularly due diligence professionals, are, by the nature of their role, adaptable and pragmatic,” notes Mr Stubbings. “Consequently, the adjustment at the start of COVID-19 to a new way of working was rapid and, by all accounts, smoother than anyone could have imagined. However, there is a danger that purely remote interactions are much more ‘transactional’ in nature.

“We must not forget what we enjoy about our work, such as meeting new clients and acquisition targets and really getting to understand how their businesses function,” he continues. “Humans are sociable animals and thrive on interaction – and there is certainly a desire not to lose this. However, the added flexibility that improved and more efficient remote working has brought can really benefit peoples’ lives when applied correctly.”

Regardless of how due diligence is carried out in the future, be it remotely, in-person or via a hybrid method, individuals on both sides of the transaction must be prepared to optimise the process. Failure to do so could have significant financial and reputational implications in the post-close phase of a deal.

Over the years, due diligence has moved well beyond merely ‘kicking the tyres’ of a potential target. It requires broad, in-depth analysis of wide-ranging aspects of a target company, on a granular level. The pandemic may have altered the way in which such analysis is carried out, but the end game is the same: verify value, identify risks, and confirm there is a foundation for long term deal success.

© Financier Worldwide

BY

Richard Summerfield