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3 priority areas for deal due diligence in 2021

Financial, Executive and Professional Risks (FINEX)|Mergers and Acquisitions
COVID 19 Coronavirus|Mergers and Acquisitions

By Giles Murphy | June 17, 2021

In this altered risk landscape, M&A issues are complex and ever-changing. The importance of thorough due diligence on acquisition targets cannot be overemphasized.

Companies have adapted to extraordinary circumstances in the last 18 months, with restrictions now easing and a successful UK vaccination rollout we are seeing some light at the end of the tunnel. Businesses are starting to shift their focus from survival to recovery. We look at this altered risk landscape and the importance of thorough due diligence on acquisition targets, noting common themes and priority areas of focus for businesses.

Shifting focus

Companies have shifted focus in recent months from controlling costs, financial restructurings and dealing with the pandemic to positioning for recovery. Deal makers have adapted too. Mergers and acquisitions (M&A) activity has risen across Europe, the Middle East and Africa (EMEA) in the first quarter; deal values have increased by 40% and deal volume was up 14% compared to 2020, according to Datasite’s 2021 Future of Transactions report. This trend looks set to continue in the second half of the year in part due to increased customer confidence.

We’ve seen an increase in carve-outs as companies opt to divest non-core assets and shore up balance sheets, with the number of distressed transactions also on the rise as companies look to refinance. In parallel we’re seeing the special purpose acquisition company (SPAC) market for deals targeting EMEA-based firms continue to rise.

In this altered risk landscape, the importance of thorough due diligence on acquisition targets cannot be overemphasized. We note three priority areas for due diligence:

  1. 01

    People

    The physical and psychological health and safety of employees is crucial. Organisations need to balance this duty with returning to business as usual. The key question we are being asked is, “How are companies planning for, implementing and communicating human capital plans in a way that is measured, effective and takes employees’ interests into account?”

  2. 02

    Risk

    In many instances organisations’ risk profiles have changed beyond recognition, whether it’s the health and safety risks posed to employees, rethinking supply chain exposure, data privacy and cyber risk, governance, regulatory and fiduciary duties owed, or contingent exposures (particularly tax and litigation) and reputational risk. With revenues, operations and exposures all in flux, clarity on how a target’s risk profile has changed is paramount to assessing the effectiveness of mitigation and risk management measures in place.

  3. 03

    Liquidity

    This global pandemic has tested the financial resilience of many organizations, putting sudden and unanticipated pressure on liquidity and working capital. A hardening insurance market (with, in many cases, premium increases and constraints on available coverage), concurrent with a contracted economy has created a perfect storm. This is leading many organisations to retain more risk and rationalise their insurance programs accordingly. We have seen a number of examples of this where organisations have taken very large deductibles or simply self-insured certain risks.

Boards and lenders need assurances that risks have been independently tested, challenged and are well understood. Data and analytics should be the front and center of this process, informing and empowering management to make rational decisions to increase resilience. As pandemic restrictions continue to ease and predicted GDP increases materialize in the first half of the year and beyond, many of these risk financing strategies will need reassessing in the search for growth.

For buyers assessing an opportunity, the challenge is to “unpick” the risk financing and transfer strategies in place with a target in order to assess the true costs within their own risk tolerances, taking into account the current insurance market climate. If the buyer is more risk averse, this can often manifest in the form of increased costs of the go forwards cost of risk transfer.

Looking ahead

The issues are complex, ever-changing and require specialist skills to perform M&A due diligence effectively. It’s difficult to tell what the lasting effects of this ongoing pandemic will be, but buyers will need to tailor their diligence to consider not only the aforementioned consequences of COVID-19, but also the potential short- and long-term implications.

Author

Mergers & Acquisitions, Due Diligence, FINEX Global

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