Due Diligence in M&A - Essay Example

 In the US, due diligence has become a requirement due to the establishment of a duty of care. The Board of directors of a company is required to exercise a duty of care that involves the performance of due diligence examination before the company acquires a business. Duty of care is a fiduciary duty for the Board but it can also be delegated (Batterson, nd). When due diligence examination is outsourced i.e. accounting professionals are hired to produce a report for an entity’s future prospects, the fiduciary duty of due diligence is delegated to the professionals.

It is not only the bidder’s responsibility to exercise due diligence but the target company also needs to provide that information to the potential buyer which is not publicly available. A significant amount of information becomes automatically available to the Board when it examines the financial statements of the target company. In order to exercise due diligence, mere dependence on financial statements is insufficient because these statements contain the opinion of an auditor regarding the fact whether the statements are prepared according to the generally accepted accounting principles. These statements do not provide a reliable forecast of the target company’s future profits. This is why a “special audit” is required to obtain relevant and reliable information (Weiner, 2010). However, in cases where a hostile bid is placed, the bidder only has the option of relying on the publicly available information of the target company. Also, the target company is not legally obligated to expose its private information in a hostile bid. Publicly available information of a company includes:

• Reports filed with the SEC, such as:

1. Annual reports on Form 10-K;
2. Quarterly reports on Form 10-Q;
3. Current reports on Form 8-K; and
4. Proxy statements prepared for annual and special shareholders' meetings. These statements contain information on the remuneration of key executives.

• Reports filed with the SEC by owners of more than 5% of equity securities, if any.
• Information reported by various news sources, or available from the internet.
• Other public records contain information regarding intellectual property, environmental matters, and litigation (Lebrun & Swann, 2013).

Legally, a bidder is usually required to focus on the following aspects of the target company while exercising due diligence:

• Contingent liabilities: Liabilities that might arise from pending litigation or environmental liabilities. This information can also be obtained from financial statements but it might also not be disclosed if it does not meet the criteria of materiality;
• Target company’s material contracts: The bidder must also examine if the acquisition would affect those contracts;
• Employee policy and issues: The bidder must examine if there are any issues regarding employee benefits or any other issues with the human resource;
• Restrictions: The bidder has to be careful with the existence of any agreements or covenants that put restrictions on the conduct of the target's business. For instance, covenants that require an entity not to compete;
• Anti-trust and other regulatory issues (Lebrun & Swann, 2013).

Further, a bidder should also conduct due diligence relating to business, finance, tax and accounting. The target may also undertake limited due diligence on the bidder’s business if the target's shareholders are to receive securities from the bidder in the transaction.

Due diligence standards in the US provide an incentive to the dealers to go through with their deals if the due diligence reports are good. Since exercising due diligence requires honest cooperation from both parties, there is a safety that the reports produced are reliable. All the liabilities are disclosed irrespective of how material they are. Therefore, due diligence standards provide great safety and incentive in mergers and acquisitions.