This was exercise

1. What is the purpose of due diligence in Merger and Acquisition and specifically, what
areas should the due diligence focus on and why?
In order to address the purpose of due diligence in a merger and acquisition, and the areas it
should focus on, there is need to define due diligence, Merger and acquisition. There are many
definition for due diligence, merger and acquisition but for this purpose these term will be
defined as follow; Due diligence, in a merger and acquisition, is a measure of prudence, activity,
as is properly to be expected from, and ordinarily exercised by, a reasonable and prudent person
under the particular circumstances; not measured by any absolute standard but depends on the
relative facts of the special case. In other words, to a potential acquirer, due diligence means
"making sure you get what you think you are paying for." Merger and acquisition are defined as
follows; Merger is a combination of two firms into one with the acquirer assuming assets and
liabilities of the target firm. On the other hand, acquisition is the purchase of the stock or assets
of another firm. Merger and acquisition can be achieved in various forms. These can be through
the buying of the stocks of the target company using cash or share exchange.
The major purpose of due diligence in a merger and acquisition is includes fully understanding
all of the obligations of the company: debts, pending and potential lawsuits, leases, warranties,
long-term customer agreements, employment contracts, distribution agreements, compensation
arrangements, and so others.
This article will focus on ten areas which due diligence should focus on, and these are as follows;
1. Financial Matters. The buyer will be concerned with all of the target company’s historical
financial statements and related financial issues, as well as the reasonableness of the target’s
projections of its future performance. Topics of inquiry or concern will include the following:
 What do the company’s annual, quarterly, and monthly financial statements for the last
three years reveal about its financial performance and condition?
 Are the company’s financial statements audited, and if so for how long?
 Do the financial statements and related notes set forth all liabilities of the company, both
current and contingent

2.  Are the margins for the business growing or deteriorating?
 Are the company’s projections for the future and underlying assumptions reasonable and
believable?
 How do the company’s projections for the current year compare to the board-approved
budget for the same period?
 Does the company have sufficient financial resources to both continue operating in the
ordinary course and cover its transaction expenses between the time of diligence and the
anticipated closing date of the acquisition?
2. Technology/Intellectual Property. The buyer will be very interested in the extent and quality
of the target company’s technology and intellectual property. This due diligence will often focus
on the following areas of inquiry:
 What domestic and foreign patents does the company have?
 Has the company taken appropriate steps to protect its intellectual property, including
confidentiality and invention assignment agreements with current and former employees
and consultants? Are there any material exceptions from such assignments (rights
preserved by employees and consultants)?
 What registered and common law trademarks and service marks does the company have?
 What copyrighted products and materials are used, controlled, or owned by the company?
 Does the company’s business depend on the maintenance of any trade secrets, and if so
what steps has the company taken to preserve their secrecy?
 Is the company infringing on (or has the company infringed on) the intellectual property
rights of any third party, and are any third parties infringing on (or have third parties
infringed on) the company’s intellectual property rights?

3.  What software is critical to the company’s operations, and does the company have
appropriate licenses for that software (and does the company’s usage of that software
comply with use limitations or other restrictions)?
 Is the company a party to any source or object code escrow arrangements?
3. Customers/Sales. The buyer will want to fully understand the target company’s customer
base including the level of concentration of the largest customers as well as the sales pipeline.
Topics of inquiry or concern will include the following:
 Who are the major customers and what revenues are generated from each of them?
 What customer concentration issues/risks are there?
 Will there be any issues in keeping customers after the acquisition (including issues
relating to the identity of the buyer)?
 How satisfied are the customers with their relationship with the company?
 Are there any warranty issues with current or former customers?
 What is the customer backlog?
4. Strategic Fit with Buyer. The buyer is concerned not only with the likely future performance
of the target company as a stand-alone business; it will also want to understand the extent to
which the company will fit strategically within the larger buyer organization. Related questions
and areas of inquiry will include the following:
 Will there be a strategic fit between the company and the buyer, and is the perception of
that fit based on a historical business relationship or merely on unproven future
expectations?
 Does the company provide products, services, or technology the buyer doesn’t have?
 Will the company provide key people and if so what is the likelihood of their retention
following the closing?

4.  What integration will be necessary, how long will the process take, and how much will it
cost?
5. Material Contracts. One of the most time-consuming, but critical, components of a due
diligence inquiry is the review of all material contracts and commitments of the target company.
The categories of contracts that are important to review and understand include the following:
 Guaranties, loans, and credit agreements
 Customer and supplier contracts
 Agreements of partnership or joint venture; limited liability company or operating
agreements
 Contracts involving payments over a material dollar threshold
 Settlement agreements
 Past acquisition agreements
 Equipment leases
 Indemnification agreements
 Employment agreements
 Agreements imposing any restriction on the right or ability of the company or a buyer to
compete in any line of business or in any geographic region with any other person
 Real estate leases/purchase agreements
 Contracts the termination of which would result in a material adverse effect on the
company
6. Employee/Management Issues. The buyer will want to review a number of matters in order
to understand the quality of the target company’s management and employee base, including
some of theses:

5.  Management organization chart and biographical information
 Summary of any labour disputes
 Information concerning any previous, pending, or threatened labor stoppage
 Employment and consulting agreements, loan agreements, and documents relating to
other transactions with officers, directors, key employees, and related parties
 Schedule of compensation paid to officers, directors, and key employees for the three
most recent fiscal years showing separately salary, bonuses, and non-cash compensation
7. Litigation. An overview of any litigation (pending, threatened, or settled), arbitration, or
regulatory proceedings involving the target company is typically undertaken. This review will
include the some of these:
 Filed or pending litigation, together with all complaints and other pleadings
 Litigation settled and the terms of settlement
 Claims threatened against the company
 Consent decrees, injunctions, judgments, or orders against the company
 Attorneys’ letters to auditors
8. Tax Matters. Tax due diligence may or may not be critical, depending on the historical
operations of the target company, but even for companies that have not incurred historical
income tax liabilities, an understanding of any tax carry forwards and their potential benefit to
the buyer may be important. Tax due diligence will often incorporate a review of the following:
 Country, local, and foreign incomes sales and other tax returns filed in the last five years
 Government audits
 Copies of any correspondence or notice from any tax
 Tax sharing and transfer pricing agreements

6.  Agreements waiving or extending the tax statute of limitations
9. Antitrust and Regulatory Issues. Antitrust and regulatory scrutiny of acquisitions has been
increasing in recent years. The buyer will want to undertake the following activities in order to
assess the antitrust or regulatory implications of a potential deal:
 If the buyer is a competitor of the target company, understanding and working around
any limitations imposed by the company on the scope or timing of diligence disclosures
 Analyzing scope of any antitrust issues
 If the company is in a regulated industry that requires approval of an acquisition from a
regulator, understanding the issues involved in pursuing and obtaining approval
 Confirming if the company has been involved in prior antitrust or regulatory inquiries or
investigations
10. Insurance. In any acquisition, the buyer will want to undertake a review of key insurance
policies of the target company’s business, including:
 If applicable, the extent of self-insurance arrangements
 General liability insurance
 Intellectual property insurance
 Employee liability insurance
These are some of the major ten areas due diligence should focus so that understanding of the
target company is got in order to achieve synergy. Due Diligence is focused on trying to identify
and confirm the existence of synergies between the two companies. Management must know if
their expectation over synergies is real or false and about how much synergy can we expect? The
total value assigned to the synergies gives management some idea of how much of a premium
they should pay above the valuation of the Target Company. In some cases, the merger may be
called off because due diligence has uncovered substantially less synergies then what
management expected. Another important reason for due diligence is know all of the major risk
associated with the proposed merger.

7. In conclusion Mergers and acquisitions typically involve a substantial amount of due diligence
by the buyer. Before committing to the transaction, the buyer will want to ensure that it knows
what it is buying and what obligations it is assuming, the nature and extent of the target
company’s contingent liabilities, problematic contracts, litigation risks and intellectual property
issues.
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