In the world of M&A, a signed Letter of Intent is celebrated as a victory. However, for the legal and financial teams, it really marks the moment the hard work begins. Between the first handshake and the final signature lies due diligence, the most crucial part of the deal.
Without a rigorous due diligence process, a buyer isn’t just acquiring a company’s assets; they are acquiring its skeletons. From undisclosed litigation to non-compliant contracts, the risks are substantial. Here is why due diligence is the ultimate insurance policy in any deal.
Financial reality checks
A target company’s financial statements tell a story, and due diligence verifies that story. While the target may show impressive EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortisation), a closer look can reveal a different picture. Are the revenue streams recurring or once-off? Are there “add-backs” that shouldn’t be there? Financial due diligence helps ensure that the price is based on maintainable earnings, not optimistic projections that disappear after closing.
What liabilities are you actually inheriting?
Legal due diligence is designed to uncover the liabilities, as many of the most serious risks never appear on a balance sheet. These liabilities may include:
- Legal proceedings that could bankrupt the company.
- Areas of non-compliance with various laws and regulations including; the Companies Act 71 of 2008, tax laws, and industry regulations.
- Establishing “Change of Control” clauses in key client contracts that allow them to walk away the moment the deal is signed.
Identifying these risks early allows the legal team to draft specific warranties and indemnities in the transaction agreement, shifting the risk back to the seller.
Section 197 and cultural fit
The Labour Relations Act 66 of 1995 plays a massive role in M&A. Under Section 197, in the event of a business transfer as a going concern, employees generally transfer automatically to the new employer with their terms and conditions intact.
Due diligence identifies:
- Potential severance liabilities.
- Unresolved CCMA disputes.
- “Key Man” risks—if the founder leaves, does the business collapse?
Ignoring the human element is often the fastest way to destroy value post-integration, even where the legal mechanics of the deal are sound.
Intellectual Property ownership
For tech and brand-heavy companies, Intellectual Property (IP) is often the primary asset. However, assumption is dangerous. Does the company own its code, or was it written by a freelancer who never signed an IP assignment agreement? Is the trademark registered? If the target company doesn’t own the core asset they are selling, the deal is effectively void of value.
Deal breaker or price chipper?
Ultimately, the findings of a due diligence report serve two functions. First, they can be “Price Chippers”, allowing the buyer to negotiate a lower purchase price based on identified risks. Second, they can be “Deal Breakers”, signalling that the only winning move is to walk away. In M&A, information is leverage. A thorough due diligence process ensures you have enough of it to make the right call.
Contact our Mergers and Acquisitions Team for assistance with structuring your next transaction or conducting legal due diligence.
Disclaimer: This article is the personal opinion/view of the author(s) and does not necessarily present the views of the firm. The content is provided for information only and should not be seen as an exact or complete exposition of the law. Accordingly, no reliance should be placed on the content for any reason whatsoever, and no action should be taken on the basis thereof unless its application and accuracy have been confirmed by a legal advisor. The firm and author(s) cannot be held liable for any prejudice or damage resulting from action taken based on this content without further written confirmation by the author(s).
