When you are conducting due diligence for proposed mergers and acquisitions (M&A), consider the following points:

• Focus. When entering into due diligence, you must be clear about the objective. The objective must be clearly communicated and articulated to the due diligence team.
• Materiality. Determining the appropriate level of the materiality threshold to be applied in conducting the due diligence ensures that the process is focused on the objectives and the identification of critical issues. You must determine what is reasonably likely to affect the value of what is being sold or acquired. Common sense, not just predetermined figures, should prevail.
• Confidentiality. Before the acquirer gains access to any material information, the target company usually requires some sort of confidentiality agreement from the people involved in the due diligence, especially those who have access to confidential information. This nondisclosure confidentiality agreement should permit full discussion and advice of confidential information between an acquirer and the entire due diligence team, including outside consultants.
• Logistics. It is common in a large due diligence process for an acquirer to have its own employees, together with advisors and other specialists, conducting a review. It is important that systems are in place to ensure that the entire process is coordinated and remains focused on the acquirer’s objectives. Nowadays, a virtual data room is commonly used for due diligence. A virtual data room is an online repository or library used for the storing and distribution of documents to facilitate the due diligence process during M&A transactions. A virtual data room saves time and money in the entire due diligence process.

Technological Tools

M&A transactions are complex, especially when companies deal with cross-border M&As, mainly owing to geographic diversity and the generation of huge amounts of data. Thus, it may not be possible to conduct a thorough and proper due diligence manually. Technological tools enable accurate, efficient, and effective results. They also provide necessary flexibility for the teams working on it. With the advent of cloud technology, the cost of these tools should come down as well, making them even more cost-effective.

Acquirers use the following SAP tools to facilitate the due diligence process:

• SAP BusinessObjects Watchlist Security: SAP BusinessObjects Watchlist Security helps to match internal company databases against government watchlists that help to uncover suspect transactions and noncompliance at the target company’s end.
• SAP BusinessObjects Governance, Risk, and Compliance (GRC): The SAP BusinessObjects GRC solutions help the acquirer develop a preventive, real-time approach to governance, risk, and compliance. The analysis helps the acquirer to decide whether to proceed with the transaction after analyzing the risks highlighted by this solution, and looking into the governance and compliance level of the target company.
• SAP BusinessObjects Risk Management: The SAP BusinessObjects Risk Management application provides a framework for enterprise risk identification, collaborative risk analysis, predefined risk responses, and risk monitoring and reporting.
• SAP Environment, Health, and Safety (EHS) Management: The SAP EHS Management application streamlines all activities necessary to implement health and safety processes safely, effectively, and in accordance with laws and regulations. SAP EHS Management helps manage product safety specifications, hazardous substance inventories, and risk calculation.
• SAP BusinessObjects Access Control: The SAP BusinessObjects Access Control application helps heads of compliance, IT security, and auditing confidently manage and reduce access risk across the enterprise. The software helps to prevent unauthorized access and achieve real-time visibility to access risk, while minimizing the time and cost of access management and compliance.
• SAP StreamWork: SAP StreamWork helps to unite information and methods to drive swift, collaborative, informed decision making. SAP StreamWork also helps the acquirer to brainstorm, structure discussions, and build consensus on the transaction under consideration.

Any business transaction has its share of inherent risk. Due diligence from an acquirer’s perspective is about understanding, managing, and mitigating such risks. Any M&A transaction involves some of the following risks:

• External: Political risk associated with the countries in which the acquisition is targeted
• Legal: Is the company following the applicable rules and regulations? Is it legally compliant? Are there any existing liabilities that may cause future disruption to the operations or financial performance of the target company?
• Financial: Are the historic financial accounts of the target company accurate? Do these accounts contain any material misstatements? Do the accounts reflect a true and fair view? Does the target company have a good title to its assets? Are the assets worth what the target company says they are?
• Relational: Do the stakeholders — key staff, suppliers, and customers — plan to continue their relationships with the company?

The target company typically has knowledge and information about these risks and legal issues, whereas an acquirer does not. Therefore, an acquirer needs to investigate thoroughly to make up for this imbalance in knowledge between the target company and the acquirer. Once those risks and legal issues are identified via due diligence, the burden of where the risks fall (i.e., on the acquirer or the target company) can be negotiated, and the acquirer can decide whether to proceed with the M&A transaction.

The aforementioned SAP tools help an acquirer to identity the target company’s risks and legal issues. We explain how each of these tools can be used to facilitate the due diligence process during the M&A transaction.

1. SAP BusinessObjects Watchlist Security Software

Certain circumstances may put the target company at risk, such as the target company’s existing or prospective customers’ involvement in illegal activities. Tracking these customers or prospects using available government and private-agency watchlists may not be possible manually. Export control mechanisms, trade with prohibited countries, and trade in prohibited items are good examples of what needs to be minutely tracked from a compliance perspective.

Compliance regulations are changing radically, and in cases involving cross-border deals, it is important for the acquirer to ensure that the target company is not in material default in compliance management. Furthermore, there has been increased enforcement of the USA PATRIOT Act, the Bank Secrecy Act (BSA), and the Office of Foreign Asset Control (OFAC) regulations. Therefore, it is even more important for the acquirer to make watchlist compliance a key part of its due diligence strategy.

When performing due diligence of customers or the prospective customer of the target company, you must implement a compliance solution for processing the available government and private agencies’ watchlists and assess the compliance health level of the target company.

SAP BusinessObjects Watchlist Security software matches company databases against watchlists to uncover suspicious transactions and to prevent the unknowing support of identified criminal suspects (e.g., terrorists, money launderers, drug traffickers, or individuals from sanctioned countries).

With robust business intelligence and information management functionality, SAP BusinessObjects Watchlist Security helps protect the acquirer from the risk of doing business with unacceptable people and entities. SAP BusinessObjects Watchlist Security helps the acquirer to uncover suspicious transactions and help organizations achieve compliance with the USA PATRIOT Act, the Bank Secrecy Act (BSA), and Office of Foreign Assets Control (OFAC) regulations.

2. SAP BusinessObjects GRC Solutions

In most of the M&A deals, in addition to financial parameters, the acquirer also looks into the target company’s nonfinancial parameters such as potential risks, compliance level, and governance level before making a decision about going ahead with the proposed deal. Although companies can use various solutions to prepare a financial model to judge the financial viability of the proposed deal, the target company has to manually look into these nonfinancial parameters. The acquirer looks for evidence that the target company is conducting its operations effectively, profitably, and responsibly.

Because of recent corporate scandals and increased attention on corporate responsibility, improved governance, risk, and compliance in the target company is a top priority for an acquirer. It is also important for the acquirer to have a clear picture of any operational weaknesses in the target company that could hurt corporate performance after a deal closes (e.g., nonavailability of raw materials or an injunction order passed by authorities to stop production).

SAP BusinessObjects GRC solutions help an acquirer identify the best strategic and operational performance by enabling the acquirer to evaluate and manage business risks; efficiently implement financial and operational controls embedded within business processes; and create a transparent, reportable environment. SAP BusinessObjects GRC solutions support the automation of end-to-end GRC processes (including corporate policies, governance, and comprehensive oversight, risk management), and compliance management (including reporting and audit trails). The SAP BusinessObjects GRC solutions act as strategic business weapons to increase efficiencies, reduce compliance costs, and improve predictability and performance.

SAP BusinessObjects GRC solutions help to maximize strategic and operational performance by providing visibility across risk and compliance activities and reducing governance, risk, and compliance costs while managing risks across the extended enterprise of the target company. The analysis offered by SAP BusinessObjects GRC solutions helps the acquirer to form proactive business strategies and decisions instead of simply reacting to business risks and events. By managing and evaluating governance, risk, and compliance across the extended enterprise, the acquirer can evaluate and align processes and strategies of the target company with the acquirer.

3. SAP BusinessObjects Risk Management

Every M&A transaction comes with risks related to the target company. The business consideration may outweigh the risks involved in the deal, and parties may decide to go ahead with the transaction based on those considerations. Having a clear idea about a deal’s probable risks helps the acquirer to make the right decision. Because risk management is often regarded as a theoretical exercise with no practical methodology, the due diligence team is equipped to properly analyze risk-reward trade-offs and carry out appropriate responses that are backed by quantitative metrics.

SAP BusinessObjects Risk Management addresses these issues by enabling the due diligence team to identity financial, legal, and operational risks in the target company. SAP BusinessObjects Risk Management provides a framework for enterprise risk identification, collaborative risk analysis, predefined risk responses, and risk monitoring and reporting so that the acquirer can effectively anticipate and make a well-informed decision on whether to go ahead with the deal.

4. SAP EHS Management

The manufacturing sector is subjected to various environmental, occupational, and chemical and product safety regulations. Noncompliance under complex regulations such as the Restriction of Hazardous Substances (RoHS) directive and the Health and Safety at Work Act makes directors directly liable for any untoward event that takes place. It is very difficult for an acquirer to ensure that the target company has been managing its operations effectively under these regulations and that the target company is compliant.

SAP EHS Management streamlines all the activities necessary to implement health and safety processes safely, effectively, and in accordance with laws and regulations. SAP EHS Management helps manage product safety specifications, hazardous substance inventories, and risk calculation. Environmental compliance functionality within SAP EHS Management helps organizations run business operations in an environmentally responsible manner. This functionality enables a company’s processes to meet legal requirements concerning air emissions, water pollution, and waste management. In addition, it supports compliance with regulations or company policies related to environmental processes, particularly compliance reporting and permit management. The due diligence team uses this functionality to judge the target company’s current level of environment-, health-, and safety-related compliance and, accordingly, assess the risks involved owing to any noncompliance of these regulations.

5. SAP BusinessObjects Access Control

Many of the recent corporate scandals, including Enron, have come about because of the destruction of key documents. It is important for companies to have proper control of key information assets, and access to these assets should be given to only selected personnel. Post-Enron, regulatory mandates around the world (such as the Sarbanes-Oxley Act and the 8th EU Directive) have put in place effective fraud and mistake safeguards over key information assets. In due diligence, it is impractical to share all the data with the entire due diligence team. Certain selected and relevant data is shared only on a need-to-know basis. SAP BusinessObjects Access Control enables companies to confidently control access over information by intelligently managing authorizations, allowing authorized exceptions, and accelerating resolution of any violations.

6. SAP StreamWork

E-data rooms are fast emerging as the most acceptable form of due diligence. Except for security and confidentiality concerns, an e-data room is the best technological tool for companies to save time, bandwidth, and money. Many companies (e.g., ShareFile) provide a safe, secure means of Web-based file transfer and virtual data room solutions. The software provides watermarking capability, user access, and a download facility. It also creates a log of those accessing the e-room. SmartRoom’s technology provides a dedicated, Web-based platform to securely share documents, streamline workflow, collaborate with additional partners, and prepare data for future use.

In most due diligence activities, the various departments of the acquirer’s due diligence team prepare an individual report concerning only their respective departments. Sometimes it is not possible to make a decision that includes all departments’ recommendations. SAP StreamWork is a collaborative decision-making solution that brings together the people, information, and proven business approaches to drive fast, meaningful results. SAP StreamWork helps ensure that everyone is on the same page. SAP StreamWork also enables users to share documents and data all in plain view, and it provides a structure with tools for brainstorming and decision making. SAP StreamWork not only brings together the right information and proven business approaches to streamline discussion, strategizing, and decision making but also guides people to take action. SAP StreamWork helps companies move from collaboration to action, give structure to a discussion, and create a collective view with embedded business tools. SAP StreamWork helps make the best decisions by collectively analyzing the data available.

It is necessary for the acquiring party to be fully aware of the risks associated with the assets to be acquired. The due diligence process red-flags critical issues that an acquiring entity should consider before closing an M&A deal. In the absence of thorough due diligence, the acquiring party is flying blind, and it may face issues that add to the overall cost of acquisition. All risks can’t be completely eliminated, but with the proper tools in place, they can be managed, and a possible mitigation strategy can be put in place. A well-performed due diligence is one of the most crucial factors for the success of any M&A transaction.

Technological tools are key to the target and acquirer in a due diligence exercise. An acquirer can use various SAP tools to ensure that the entire due diligence exercise is completed in the most efficient and optimal manner, and, at the end of the day, that the acquirer is informed about the due diligence findings. Investment and use of technological tools are essential for time-bound and efficient due diligence.

Vivek Sadhale

Vivek Sadhale is a company secretary and head — legal and investor relations of Persistent Systems Ltd., one of the leading outsourced software product development companies with a turnover of about US$127 million and more than 5,500 employees. He has 14 years of hands-on experience in corporate secretarial, corporate governance, investor relations, mergers and acquisitions, capital market transactions, and international legal matters, with exposure to management accounting, finance, and treasury functions within reputed Indian and multinational organizations. A commerce and law graduate, Vivek completed his chartered secretaryship exam in the UK and is a qualified company secretary and management accountant in India.

You may contact the author at vivek_sadhale@persistent.co.in.

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