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Due Diligence: Common Mistakes and How to Avoid Them

Due diligence is one such term that you might understand on the surface but face challenges when required to put into practice.

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CIOL Bureau
New Update
Due Diligence

Comprehensive due diligence is essential to any PE and VC firm for making the right investment. But, getting a complete and transparent view of financial risks and rewards associated with an investment is not easy. Even the big brands in the world make due diligence mistakes. Hence, the investment/acquirer firm needs to be aware of due diligence blunders to avoid financial burden.

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Due diligence is one such term that you might understand on the surface but face challenges when required to put into practice. It is not just an investigation but the ability to evaluate and understand a target company. There are multiple types of due diligence that provide acquirer/investor with the knowledge to get exactly what they want out of a prospective deal, comprising detailed study of financial, commercial and legal aspects before investing in/acquiring a company.

Commercial due diligence, which provides a full overview of the target's internal and external environment and financial due diligence, which focuses on the financial health of the target company, play a significant role in understanding the true value of a company.

Commercial Due Diligence

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Commercial due diligence helps the acquirer/investor to analyse company performance and the likelihood that the business will meet its targets. The report also highlights potential opportunities and problems that may occur as a result of an acquisition/investment.

The primary benefit of conducting commercial due diligence is that it gives a thorough understanding of the target company's position before negotiations begin and thus helps the buyer to make informed decisions during a potential acquisition/investment. Additionally, it allows the acquirer/investor to determine whether an investment in/acquisition of the target is likely to yield a profitable long-term investment.

Let’s explore common mistakes or blunders of due diligence that can impact the success of a transaction:

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1. Primary Focus on Making the Deal

Acquirers/investors usually fail to address vital integration and operational factors and their focus is largely on executing the deal. In the haste to make the deal, important factors like product quality, team expansion capability, competition/operational risks get ignored which ideally should not happen as these fundamental issues can hamper an organisation’s growth.

2. Focus on Financial Parameters Alone

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Due diligence has a wide scope if it covers a detailed study of the intensity of competition, strategic approach, market outlook, cultural differences and organisational capabilities rather than focusing on financial performance alone.

3. Belief in “One Size Fits All”

Acquirers/investors usually make the mistake of treating two or more transactions alike and thus ignore understanding the core purpose of individual deals. They must treat every transaction unique to crack a successful deal.

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4. Blind Focus on Checklist

Checklists are important but they just give a path to effective due diligence and are alone not enough. It is important for due diligence providers to not blindly focus on checklists and draw useful insights that can be critical to the success of the transaction. Over-reliance on ticking the checklist usually fails to deliver effective due diligence.

5. Ignoring the Importance of Sector Experts

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Expecting the generic analyst to carry out the due diligence process on his own is not justified. Due diligence providers must understand the importance of sector experts as they can help provide critical insights specific to a sector and thus lead to successful due diligence.

6. Reliance on Profit and Loss Statement Alone

To make the due diligence successful, one must not focus on the P&L statement alone as they do not tell the complete truth of an organisation’s position. It is extremely important to carry out a detailed study of drivers and assumptions and cross-question them with industry standards before concluding.

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7. Ignoring the Competitive Aspect

Most due diligence providers usually fail to assess the competitiveness of a company i.e. its ability to perform in the competitive scenario. However, it is a crucial aspect of commercial due diligence as it helps to analyse the target for future success and its capability to hold a significant market share.

8. Over-Reliance on Management Information

Most due diligence providers make a common mistake of relying on management information. The information is important, but it only provides a guideline. If the analyst wants to deliver successful due diligence, it is his responsibility to ask counter questions to the management to get the real scenario.

9. Limited Focus on Physical Checks

Reviewing the business data on paper alone is not enough. Onsite inspection is important to understand the real picture of the target business. This requires the due diligence team to physically visit the site and customer touchpoints, interact with employees and take customer reviews so that the assessment is based on practical observation and not theoretical observation alone.

To be able to select the right due diligence provider, the acquirer/investor needs to be aware of pitfalls and understand the due diligence process in detail. Rushed due diligence and over-dependency on management information can have adverse effects including large loss for the investing firm.

An efficient due diligence provider is the one who is aware of the challenges and delivers comprehensive due diligence, ensuring the result adds value to the client’s decision. Due diligence providers must understand that each exercise is exclusive and unique and onboarding an industry expert is extremely important.

 Siddharth Jaiswal, Manager, Business Research & Advisory, Aranca