Key Focus Areas of Due Diligence in French M&A Transactions: Financial, Legal, and Commercial

Financial Due Diligence

Financial due diligence focuses on confirming the financial performance of the target business as presented. Buyers need to go beyond reviewing balance sheets to assess the true financial stability of the company. Key areas of focus include:

• Reliability of Reported Financials: Ensuring the accuracy and reliability of the target company's financial statements.

• Underlying Earnings: Understanding the true earnings potential of the business.

• Key Drivers of Earnings: Identifying the factors that drive the company's profitability.

• Trading Performance: Assessing the current trading performance of the business.

• Investment in Fixed Assets: Evaluating whether the business has sufficiently invested in its fixed asset base.

• Financial Position: Analyzing the overall financial health and stability of the business.

• Net Working Capital: Determining a "normal" level of net working capital for the business.

• Forecast Growth Drivers: Verifying if the forecast drivers of growth are supported by historical data.

• Internal Controls: Assessing the effectiveness of the company's internal controls.

• Revenue Quality: Examining the sustainability of revenue streams and identifying potential risks such as high customer concentration.

• Cash Flow Health: Analyzing cash flow to ensure the business can meet its obligations and fund future growth.

• Hidden Liabilities: Identifying potential off-balance-sheet risks such as legal claims, deferred taxes, or earnout commitments. Many failed acquisitions result from financial oversights that should have been identified during due diligence.

  
  

Legal and Tax Due Diligence

Legal and Tax due diligence is primarily concerned with identifying potential off-balance sheet liabilities and understanding the target company's corporate structure. Acquirers closely examine several key areas to avoid deal-breakers and post-merger legal disputes:

• Regulatory Compliance: Scrutinizing the target's compliance with applicable laws and regulations, especially in highly regulated industries like finance, healthcare, and technology. Even minor compliance issues can lead to significant fines or block the deal.

• Contractual Obligations: Reviewing key contracts to understand the target's rights and obligations. Thorough legal diligence minimizes the risk of financial valuation, regulatory issues, contract disputes, and unforeseen liabilities post-acquisition.

• Intellectual Property Protections: Assessing the strength and scope of the target's intellectual property rights, such as patents and trademarks. Weak protections for key talent and IP can undermine the deal's long-term success.

• Employment Agreements: Reviewing employment contracts, including those of key employees, to understand potential liabilities and ensure talent retention.

• Required Permits and Licenses: Verifying that the target company possesses all necessary permits and licenses to operate its business.

• Litigation and Disputes: Identifying any existing or potential lawsuits or legal disputes that could impact the business.

• Tax Due Diligence: This involves an assessment of a target's tax compliance, liabilities, and structuring to identify risks and opportunities before a transaction.   

  
  

Commercial Due Diligence

Commercial due diligence evaluates the target company's market position, growth potential, and customer concentration risks. It assesses the external factors that can impact the success of the acquisition:

• Market Dynamics: Understanding the competitive landscape and the target's position within its industry.

• Growth Potential: Evaluating the potential for future growth in the target's market and the target's ability to capitalize on these opportunities.

• Customer Concentration: Assessing the risk associated with reliance on a small number of key customers. Losing a major client could significantly impact the company's value.

• Market Share and Growth: Analyzing the target's market share in relation to the overall market growth rate. A company growing at a slower rate than the industry may not be as strong as it appears.

• Business Plan Validation: Verifying the feasibility and potential of the target's business plan.

• Customer Loyalty: Assessing the strength of customer relationships and the likelihood of customer retention. A well-executed commercial due diligence process ensures the deal is built on a strong market foundation, not just internal performance metrics.

  
  

Other Due Diligence Processes

In addition to financial, legal, and commercial due diligence, several other types of due diligence processes are increasingly important in M&A transactions:

• Operational Due Diligence: This assesses the target company's supply chains, cost structures, workforce stability, and technology readiness to ensure a seamless post-merger transition. Key factors include supply chain and cost pressures, workforce and culture risks, and technology debt. Companies prioritizing operational diligence tend to integrate faster and extract value more effectively.   

• ESG Due Diligence: This evaluates a company's environmental impact, governance policies, and social responsibility to assess regulatory and reputational risks.   

• IT & Cybersecurity Due Diligence: This reviews a company's technology infrastructure, data security, and cyber resilience to identify vulnerabilities and integration risks. Historically, this area was often included in other categories but is increasingly recognized as a critical standalone area.   

  
  

Conclusion

M&A success depends on thorough, well-executed due diligence across financial, legal, commercial, operational, tax, ESG, and IT & cybersecurity areas. It is essential for companies to understand and implement comprehensive due diligence processes to improve their chances of achieving desired outcomes and creating lasting value. Remember that due diligence is a strategic tool that, when properly executed, can make the difference between a successful merger and a costly mistake. For more information about implementing these strategies in your M&A process, consider consulting with experienced M&A advisors who can provide industry-specific guidance and support.