Startups usually celebrate the day after getting listed on the stock exchange. It’s a dream and aspiration for many. Still, the best way to exit even today is through acquisition. Latest data shows that about ten times more acquisitions were made in 2022 than companies going public. In these cases, one startup typically acquires the other startup after conducting a thorough due diligence. A good deal can easily slip through the crack without proper scrutiny, or a bad deal can botch the entire acquisition experience. So, how do you avoid catastrophe through appropriate due diligence? Let’s get into the buy-side due diligence.
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Interrogating one’s acquisition strategy
Due diligence practices vary based on the deal’s nature and the reasons for acquisition. Before getting into the details of the target startup, you want clarity about your intention to buy it, no matter how affordable the transaction may seem. Sound reasoning will help you drive a transaction in a particular manner and get precise details through due diligence. You can pursue acquisition for any of the following goals:
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Gaining accessibility to a specific IP or technology to grow one’s products.
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Accessing the product built by another startup.
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Creating new market opportunities, such as fintech, for a faster transaction.
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Acquiring people and talent.
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Market mapping
Whether you involve your internal resources or hire advisors, you will need their support in commercial due diligence, product due diligence, tax and financial due diligence, and legal due diligence. The investigation approach will depend on deal size, stage, regulatory environment, business type, geography, etc. Suppose you are chasing a tech or product, which is a low-value acquisition. In this case, you can proceed without doing extensive financial due diligence. However, there can be various things to consider on the legal front to learn about IP rights, such as whether they are protected, product compliance with regulations, etc.
If the transaction amount is significant, the conditions will be different and more complex. It will demand careful financial due diligence. You may need auditors to prepare a red flag report of about 20 pages and a lengthy financial document exceeding 250 pages.
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Conducting a high level of due diligence
If you initiate this process, you will want to examine two years of financial reports, one year of management account details, revenue growth in the past two years, and the startup’s top customers.
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Doing the last thing
If a startup agrees to buy another startup after all the considerations, legal due diligence will be initiated to investigate further details. These will cover areas like termination rights after a change in control, types of existing contracts and their fate, lawsuits, the company’s owner, employee retention and returns, etc.
It’s a hint of what due diligence processes and systems entail. The entire exercise can be rigorous, as every detail adds value to the deal assessment. You must have heard about how some of the biggest deals fell apart or bombed after the acquisition. Such incidents happen when an essential item in the checklist is inadvertently removed or ignored. That’s why one must be alert even about acquiring a small startup. You want to place your bet in the right place.
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