What’s expanding the due diligence scope?

Average deal durations sit at 7.5 months

Ansarada’s Deal Indicators data shows that there was little change to the length of deals over the course of 2022, with the average deal duration sitting at around 7 and a half months. 
 
Similarly, the average number of bid groups during M&A transactions also steadied at around 5.5 over the course of the year. 
 
Much in line with the broader M&A outlook, a steadying of the numbers indicates a return to normal across the industry as a whole, and a further stray away from the frenzied dealmaking pace of 2021. 

However, with a renewed focus on sustainability and ESG, it is expexted that added requirements at the due diligence phase will extend deal timelines in the short-term future.

"We're seeing less auction processes, more selective or even bilateral processes; also more preliminary ‘coffee table’ chats to gauge interest before kicking off a process. Processes take longer in general (+6 months to close a deal). In-depth due diligence preparation is key to speeding up the process, as ESG is becoming more and more important in M&A, even for smaller transactions," says Margot Snoeck, Manager, Corporate Finance Advisory, Deloitte.

 

Sustainability reporting & cybersecurity top list of driving factors 

The approach to due diligence in 2023 seems to be one of caution. Due diligence is going further in depth. Lawyers are getting more involved in the process and coming in earlier than they usually would. 

When we put this question to webinar attendees of our Indicators Deal Trends series, the top two factors expanding the scope of due diligence were Sustainability Reporting and Cybersecurity & Data Privacy, both of which fall under the umbrella of growing ESG concerns & requirements.
 

1. Sustainability reporting

ESG due diligence is gaining recognition as a critical factor in M&A deals and capital raises due to the growing demand for companies with ESG credentials. ESG-driven due diligence can help maximize the value of every transaction and minimize risk in the face of increasing demands from stakeholders and regulatory bodies. 

Well-structured information and processes are essential for companies to address ESG issues proactively, which is why the European Union has introduced the Corporate Sustainability Reporting Directive (CSRD) which requires all large companies to publish regular reports on their environmental and social impact activities. CSRD needs to help investors, consumers, stakeholders to evaluate companies’ non-financial performance, like diversity on company boards, or environmental protection.

Companies must submit their report aligning with the CSRD in 2025 for the FY24, meaning that all large companies need to take actions now. CSRD will bring transparency in the market and make sure we can compare ESG actions and companies better – but it will almost certainly extend due diligence timelines.

Depending on the type of industry, companies who engage in ESG can achieve higher valuations, secure favourable financing (sustainability-linked loans & bonds), receive government incentives and “green” tax credits and enjoy promising growth prospects.

We can expect to see an increasing number of ESG-driven acquisitions and ESG DD being conducted; dealmakers will continue to eye M&A as a means to accelerate the digital and environmental, social and governance (ESG) transformation of their businesses.
 

2. Cybersecurity & data privacy

In the current cybersecurity environment, it’s expected that due diligence may take longer due to the increasing risks and threats associated with digital infrastructure. As highlighted by KPMG, ESG and cybersecurity are interconnected, and the reliance on digital infrastructure will continue to grow, making cybersecurity threats a significant concern for companies. The ramifications of a cybersecurity breach can be severe, impacting every aspect of daily life, from communication systems to critical infrastructure like water and wastewater facilities.

Given the growing importance of ESG and cybersecurity in the business world, high-quality data needs to sit at the centre of these strategies. Due diligence will require significantly more scrutiny to validate the security and safety of these assets. It is crucial to ensure that the target company has implemented adequate cybersecurity measures and has a robust cybersecurity framework to safeguard against potential threats.

This may include a comprehensive review of the target company's cybersecurity policies, procedures, and systems, involving conducting penetration testing to identify vulnerabilities as well as a thorough risk assessment to evaluate the potential impact of a cybersecurity breach. Additionally, it may involve assessing the target company's compliance with relevant regulations and industry standards and reviewing the company's incident response plan.

As ESG and cybersecurity become increasingly interconnected, it is essential to ensure that target companies have adequate cybersecurity measures in place to safeguard against potential threats. 
 

3. Addressing the valuation gap

As a lot of companies are – or were – suffering from supply chain issues, the Ukraine crisis, and other uncertainty, buyers seem to be holding back more in terms of valuation. While sellers may still have the valuations of two years ago in mind, buyers are doing more in-depth due diligence to justify their purchase.  Currently, transaction financing is also more expensive and difficult, which drives the valuation down from a buyer perspective – another cause behind the widening valuation gap we are currently seeing between buyers and sellers.

Ultimately, this gap comes down to misalignment of expectations from both the seller and buyer’s perspectives, which has widened over time because of the macro environment. To align expectations, more upfront planning and communication needs to occur early on, bridging that gap by helping paint an accurate picture of the seller’s financial performance. 
 

The context calls for caution

While this is by no means an exhaustive list, it’s certainly an interconnected one. 

We can attribute a potentially cautious approach to deals this year on headlines of data breaches, the growing threat of climate change, mandated sustainability requirements, the uncertain market, the collapse of major financial institutions, geopolitical risk and tension… it should be no real surprise that the due diligence process will take longer. People want as much confidence and control as they can get amid such a backdrop.

One thing is clear: Companies need to be organized long before the process starts. By anticipating requirements – especially ESG – and staying ahead of the game in terms of structured documentation and data, they can maintain a smooth and efficient due diligence process.