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What are the biggest red flags you look for during due diligence? And when is a red flag a showstopper or just a challenge?
From a compliance stand point, we look for potential risks for the parent organizations, e.g., high risk contracts, partners, or geographies.
Within the SME space, I look for key employee and customer concentration risk, quality of earnings, family entanglements (i.e., does the son or daughter of the seller work in a key function).
I don’t think any red flag should ever be classified as a showstopper, except when it is clear and obvious misinformation. I believe red flags are additive. The biggest issue, in my opinion, is 1. not recognizing a red flag and being surprised later, and 2. not connecting the dots between different red flags.
Sometime the realization of outside influences, such as labor unions can stop the process. In fact, the only time I have seen us get deep into the process and stop was as a result of unresolved labor union issues.
I think in DD the goal is to look for things that can go wrong and have a significant effect on the company. For example a lawsuit that could ruin the companies reputation – this would probably be a showstopper if you felt the lawsuit had merit. Some of the risks can be mitigated – for example if a certain business is not wanted , it could be sold prior to the M&A.
I agree with Brian, DD if done well points out the ‘red flags’. However whether that red flag stops the deal or just adds complexity to the integration is another conversation. For instance I am working on an integration plan right now that has a couple of what I would call red flags. These red flags won’t stop the deal but they will get extra attention as a part of the integration planning and execution.
I think at due diligence, the biggest red flags are non-compliance of laws and litigation and this can have serious impact on the value of the target company but can also bring out worse issues once the deal is signed.
From legal and compliance side red flags are mostly: ownership of movabel and inmovable property, possession of all permits required for business (environmental protection, use permits, etc.) If the red flags can’t be fixed after takeover all the costs are too large and exceed the benefits of the acquisition, they are a showstopper.
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