Vendor Due Diligence in M&A Transactions: A Seller’s Guide to Reports and Service Providers

31 March 2023

By Zachary Cefaratti

Embarking on a mergers and acquisitions (M&A) process is a complex, costly and time-consuming endeavor. To ensure a smooth and successful transaction, sellers often rely on various vendor due diligence reports and service providers to prepare for negotiations with potential buyers. Sellers often get different recommendations from different advisors about what reports are needed, the scope of those services, and the costs.

Types of Vendor Due Diligence Reports

1. Financial Due Diligence Report: This report analyzes the financial health and performance of the target company, providing insights into historical and projected financial results, working capital requirements, and potential financial risks. It serves as a key tool for buyers in assessing the target’s financial stability and determining an appropriate valuation.

2. Commercial Due Diligence Report: A commercial due diligence report assesses the target’s market position, competitive landscape, growth prospects, and key risks. It aims to provide a comprehensive understanding of the company’s commercial environment and potential strategic synergies with the buyer.

3. Legal Red Flag Report: This report identifies potential legal risks and compliance issues that may impact the transaction. Legal red flag reports typically cover areas such as corporate structure, contracts, intellectual property, litigation, and regulatory compliance. These reports are used internally to prepare for, pre-empt and seek to rectify legal issues that are likely to come up in due diligence later on.

When Vendor Reports Are Necessary

Vendor due diligence reports are particularly important in the following scenarios:

1. Auction Processes: In competitive auction processes, having comprehensive due diligence reports in place is critical to provide buyers with the necessary information to make informed decisions and expedite the bidding process. It is critical that the bidders each have reliable reports and information so that they can put in the best possible bids.

2. Wide Range of Buyers: When dealing with a diverse pool of potential buyers, especially those with varying levels of familiarity with the target’s industry or market, vendor due diligence reports can help ensure that all parties have a consistent understanding of the target company’s performance, prospects, and risks.

VDD is typically provided by the Big 4, however in some cases smaller specialist firms can be more appropriate

When Vendor Reports Are Less Needed

1. Familiar Buyers: If potential buyers are already well-versed in the target’s industry or market or with the target company, they may not require as much information to understand the company’s value proposition and risks. In these cases, sellers may opt for a more streamlined approach to due diligence, focusing on key areas of interest for the buyer and allowing the buyer to appoint its own vendors (if any), without any sell-side vendors.

2. Smaller Transactions: In smaller transactions or deals with lower levels of complexity, the cost of comprehensive vendor due diligence reports may outweigh their potential benefits. Instead, sellers might choose to focus on providing essential information and addressing specific buyer concerns on a case-by-case basis.

3. Strategic Acquirers: When the buyer is a strategic acquirer with a deep understanding of the target’s business and industry, they may not require extensive third-party reports to evaluate the transaction. In such situations, sellers can leverage the buyer’s existing knowledge and prioritize addressing any specific concerns or questions that may arise during negotiations.

4. Relationships and Trust: In cases where there is a high level of trust and a strong relationship between the buyer and seller, the need for comprehensive vendor reports may be diminished. Both parties can work together to address any concerns and share information directly, potentially reducing the reliance on third-party due diligence reports.

Boutique Financial Advisors vs. Big Banks wrt Vendors

Boutique financial advisors often offer a more personalized and cost-effective alternative to large financial institutions by providing tailored due diligence services and reducing the need for vendors. Key advantages of working with boutique advisors include:

1. Reduced Costs and Time: Boutique advisors are generally more flexible in their approach and can perform many of the tasks typically handled by external vendors, potentially saving time and reducing costs for sellers.

2. Willingness to take on additional work: Large banks typically are unwilling to take on potential liabilities. For example, while the internal legal teams of any investment bank could easily help with minor items like NDAs or reviewing minor documents, large banks will not allow their legal departments to support an external client and will require the clients legal counsel to take responsibility for all such work — which can cause delays and increase costs.

3. Customized Solutions: Boutique advisors are better positioned to tailor their services to the specific needs and circumstances of the seller, offering bespoke solutions that cater to the unique aspects of each transaction. For example, setting up and managing deal data rooms can be a costly and onerous — boutique advisors are often willing to do this on behalf of the client rather than requiring the client to manage themselves

In contrast, big banks often rely on third-party vendors for due diligence services, which can increase costs and extend the M&A process.

 

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