Zandra Guerrero, Acting Partner, BDO, on the importance of conducting due diligence: Viewpoint

In view of the fact that economies are strengthened through accelerated, and in some cases, sustainable growth, businesses and economic groups seek to expand through mergers and acquisitions as a corporate economic strategy. In these processes, it is of vital importance for the investors to be able to identify possible risks or contingencies associated with the assets, liabilities and businesses that could have an impact on the transaction.

For this reason, the due diligence process was developed as a tool to assist the investor or purchasing company in making their decision to acquire or invest in a company. Normally, due diligence processes are carried out before any agreement has been signed between the parties; that is, in the pre-contractual stage of negotiations.

The process of due diligence is based on the analysis and evaluation of the company in question from various perspectives: financial, tax, legal and technical. The financial investigation aims to identify risks and contingencies associated with uncertain assets, unregistered liabilities or the generation of results that do not match reality. The tax investigation seeks to verify that the target company in question has complied with all its tax obligations, and to identify any possible contingencies arising from tax issues. From a legal perspective, the process analyses the company’s contractual and corporate situation, aiming to identify anything that might imply an unusual or extraordinary obligation. It also analyses the company’s compliance with employment regulations in each country, and any processes of litigation in which the company is involved. Due to its scope and the wide variety of areas investigated, due diligence is carried out by a team of multi-disciplinary professionals, including lawyers and specialists in accounting, finance, tax and technology.

Based on information previously gathered, analysed and evaluated by the financial, legal and tax teams, a report is produced. Typically, the structure and content of such reports allows the user – the investor company – to have knowledge of the main risks or contingencies that could be associated with the acquisition, and to which special attention must be paid, in order to find alternatives and mechanisms that enable faster negotiations. This document is normally confidential; therefore, the letter often mentions that the report is of limited use to investors.

It is important to highlight that the due diligence process should not be confused with a financial audit, as the objective, reach and procedure is significantly different. The main aim of due diligence is to identify – based on financial, fiscal, legal and technical analyses of the business – risks and contingencies that could affect the process of acquisition, whereas financial auditing is done according to international auditing regulations, which aim to provide an opinion on the state of the target company’s finances during a particular period of time.

Once they have been provided with the results of the due diligence process, investors can have a certain degree of confidence, allowing them to proceed with negotiations and come to a final agreement. Normally, if the due diligence highlights any risks or contingencies associated with the target company, depending on their severity, agreements will be drawn up so that the seller takes responsibility.

The purchasing party usually covers the cost of the investigation and, although it can be costly, it should be considered as an investment. When compared proportionally with the proposed value of the investment, it is actually a very economical service.

Finally, it is recommended that this procedure be carried out before committing to a business. The process assures the investor of the target company’s economic capacity and identifies possible risks and contingencies, as well as the best way of controlling them, in order to guarantee a successful acquisition.