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Due Diligence

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March 6, 2000 In this age of acquisitions, hardly a day goes by without an announcement of a merger, large or small. Yet many deals are based on big-picture assessments of value, without all the parties involved knowing all the details.

Quite often, a proposed merger or acquisition gets canned or valued down following conflicts over intellectual property rights, personnel, accounting discrepancies or incompatibilities in integrating information technology systems. The process of researching, understanding and, in some cases, avoiding these risks is known as due diligence.

"Due diligence is going in and digging a hole in the ground and seeing if there's oil, instead of taking someone's word on it," says Joseph Bankoff, a partner in the intellectual property and technology practice at law firm King & Spalding in Atlanta. "If you don't do a sufficient amount of due diligence, you don't really know what questions to ask."

In the case of a technology acquisition, a due diligence investigation should answer pertinent questions such as whether an application is too bulky to run on the mobile devices the marketing plan calls for or whether customers are right when they complain about a lack of scalability for a high-end system.

Meeting Expectations

Due diligence entails taking all the "reasonable steps" to ensure that both buyer and seller get what they expect "and not a lot of other things that you did not count on or expect," Bankoff explains.

The process involves everything from reading the fine print in corporate legal and financial documents such as equity vesting plans and patents to interviewing customers, corporate officers and key developers. It helps to identify potential risks and red flags.

Greg Faragasso, an attorney at the Securities and Exchange Commission (SEC) in Washington, recommends examining public filings, especially the 8-K, which the SEC requires public companies to file when an auditor resigns. The document must state the reason for the departure. "The reason an auditor resigns is very often benign and due to legitimate disagreements," Faragasso says. "But an 8-K filed by auditors that quit could be interpreted as a red flag."

Increasingly, IT systems and professionals are playing a significant part in understanding the viability of a proposed merger or technology acquisition for two reasons: Incompatible systems often take considerable time and resources to integrate, and conflicting intellectual property rights can potentially curb a deal before it takes off.

According to John Haven Chapman, an attorney and general partner at Dignitas Partners LLC, a strategic venture-capital firm in New York, many deals hinge on intellectual property ownership and key IT personnel. "Who has the rights to the intellectual property in a spin-off situation or making sure the rights stay within a venture when an employee leaves" is critical, he says.

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