Refinitiv’s latest webinar takes a critical look at third-party risk during an acquisition. Discover best practices for pre-transaction due diligence below.
- Understand how third-party risk impacts the acquisitions space against an emerging risk landscape.
- Discover best practices for pre-transaction due diligence.
- Real-world advice on managing risk with scarce resources.
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Pre-transaction due diligence: a shifting landscape
Pre-transaction due diligence has increasingly moved to centre stage alongside a shifting risk landscape. Increasingly acquiring companies are footing the bill for previously known risks within the acquired company’s third-party network. To overcome this, companies should conduct thorough third-party due diligence that goes beyond financial and legal considerations.
Such due diligence should seek to understand as much as it can about a target’s third-party network and a wide range of potential risks – from the integrity and reputational risk that an acquisition’s third parties could introduce, to an evaluation of any environmental, social and governance (ESG) concerns and much more.
Integrity risk is a particular concern for many acquiring companies. Investing in, acquiring or merging with a company that introduces this type of third-party risk can have lasting reputational consequences. As our panelists stressed, the court of public opinion can be harsh and swift.
This means that robust and thorough due diligence is non-negotiable to ensure that risks are not inadvertently inherited during an acquisition.
Before acquiring another entity, companies should investigate a broad set of potential third-party risks, for example, cyber security risks, operational risks, human rights or labour violations, poor environmental stewardship and more.
What is an essential question to ask pre-transaction?
The essential question to ask before proceeding with any acquisition is “How could this transaction hurt our company?”
Before answering this, some core areas to examine include the target’s management team and key personnel, especially the C-suite. Potential red flags include conflicts of interest, political affiliations, civil disputes or criminal charges, but the list of potential concerns is much longer.
It is also important to focus on the target’s key customers and suppliers, as such third-party risks may not be evident in traditional approaches to pre-transaction due diligence. For example, failure to understand a key supplier’s connections to high-risk entities and/or jurisdictions, and its environmental or human rights track record could result in a costly surprise after a deal is completed.
Another area to analyse and understand is the ultimate beneficial ownership (UBO) of the target company’s key third parties. The rapid increase in sanctions since Russia’s invasion of Ukraine has made ownership a key risk when it comes to third-party relationships.
These are simply some core examples of the due diligence scope that companies should undertake.
A step-by-step approach
Our panelists further recommend adopting a circular, step-by-step approach to pre-transaction due diligence, as follows:
This final point is important since due diligence is never a once-off exercise, risk can change over time and new risks can emerge, which means that ongoing monitoring is vital.
Managing scarce resources: some real-world advice
The due diligence responsibilities of any acquiring company are many and varied, and therefore ensuring that you have enough resources to complete robust due diligence can be challenging.
For example, in the real world, a target company may hand over volumes of information during the pre-transaction due diligence phase. Whilst such information may be invaluable, it can also create problems for the acquiring company – any vast inflow of data can be overwhelming.
Part of the solution is to adopt a risk-based approach: best practice involves categorising third parties into buckets from high to low risk and then drilling down into targeted areas of higher concern.
Additional advice for spending resources as wisely as possible is to leverage any due diligence already completed by the target company, although our experts stress that it remains crucial to complete your due diligence as well.
Where resources are highly stretched, best practice dictates channeling what is available towards assessing the big issues of the day, including sanctions screening, and identifying grassroots risks such as litigation.
And a final word from our panelists: if the risks attached to a particular acquisition appear too great, walk away. Adding too much risk to your existing risk profile is never wise and it is more prudent to look for an alternative investment or acquisition.