For an organization to succeed in the market, it must have a solid reputation; negative public perception resulting from unethical conduct, adverse legal and regulatory actions, and harmful business practices can result in the loss of business, customers, and overall corporate value.

While these risks are pressing enough on their own, organizations compound them when they engage in corporate transactions, including mergers and acquisitions—especially if they fail to conduct thorough reputational due diligence.

Mergers and acquisitions often come with financial, legal, regulatory, and operational concerns, all of which can impact the acquiring company’s reputation and bottom line. Successor Liability in M&A transactions means that after a purchase, the acquiring company takes on more than the target company’s assets and operations: it also assumes the liabilities of the target company. This especially risky for liabilities associated with regulatory compliance obligations because the purchaser absorbs any regulatory transgressions of its target company, such as anti-bribery corruption, anti-money laundering, and sanctions violations.. This risk can be eliminated if identified and negotiated with the regulator prior to closing.

A purchasing company can lose its position of trust in the market if it acquires a company with a poor reputation. Violations like these can result in regulatory penalties, such as fines and imprisonment. But the more detrimental effect is on the purchasing company’s brand. Violations can tank sales and stock prices. A recent study found that reputational issues cost organizations 4.5 times more than related regulatory penalties.

Luckily, reputational risk can be mitigated by incorporating comprehensive reputational due diligence into the merger and acquisition process before completing a transaction. Let’s take a look at what reputational due diligence is in more detail and the steps that organizations need to take before commencing a merger or acquisition.

What is reputational due diligence?

Due diligence entails a thorough review and investigation into the target company and its reputation and an assessment and evaluation of potential risks that may impact the deal. The benefits of implementing a robust reputational due diligence process are myriad and include using the findings to identify unacceptable risk before it is too late, renegotiating the deal as necessary, establishing strategies to mitigate further risks, and building a proactive, defensive posture against additional misconduct discovered post-sale.

Reputational due diligence should be proactive and begin early in the merger or acquisition process. The acquiring company should set reasonable yet aggressive deadlines that provide enough time for the seller to gather the necessary information and for the acquiring company to commit the appropriate resources and outline a plan of action based on the findings.

As the acquiring organization dives into the target company, it is important that its reputational due diligence encompasses the following steps:

• A review of the target company’s history and reputation in the market
• Research into the background of the target’s executive leadership and board of directors
• An evaluation of conflicts of interest
• An investigation of the target’s shareholder and ownership structure, including ultimate beneficial ownership, to ensure there aren’t connections to sanctioned individuals
• An assessment of third-party risks, including vendors and business partners
• A review of jurisdictional exposure, including exposure to sanctioned countries and territories
• A deep dive into pending litigation or other legal, compliance, or regulatory investigations
• A determination and assessment of the target’s compliance processes and risk assessments and their adequacy

The buyer must use this process to identify and remediate any red flags and gaps.

Reputational due diligence is not a one-and-done activity

Based on the information gathered in the first phase of reputational due diligence, the acquiring company must decide on its next steps. It may need to conduct further due diligence, reconsider the deal, renegotiate the deal’s value with the target, or build a compliance plan.

Thereafter, leaders need to incorporate ongoing reputational due diligence into their governance plan. Here are steps to take after the deal closes:

• Dive deeper into the target: After the transaction is complete, the acquiring company will have even greater access to the target company’s data. It should thoroughly examine the company for potential risks, including risks stemming from the target’s external partners.
• Enhance transparency and communication: The acquiring company should have proven strategies in place to ensure effective communication throughout the merger or acquisition. This plan should also have a process for responding to negative publicity or stakeholder concerns promptly and effectively.
• Strengthen corporate governance and ethical practices: As operations progress post-acquisition, the acquiring company should integrate and tailor its own compliance policies, procedures, and controls into the new risk profile and ensure that it meets regulatory scrutiny. This may include reassessment along the way and potentially implementing new ethical practices and policies, including a clear and well-communicated code of conduct. Additionally, robust and effective whistleblower hotlines and protections should be implemented. Leaders should conduct up-to-date ethics and compliance training regularly to ensure employees are trained on the most updated policies and procedures.
• Keep monitoring: Organizations should establish an ongoing reputational risk monitoring schedule. Leaders should disclose any corrupt or illicit activity to the appropriate regulatory entity and remediate any misconduct immediately. The Securities and Exchange Commission and the Department of Justice are likely to look favorably on companies that self-report violations.

Reputational due diligence is a critical and necessary element of any corporate transaction. Organizations must take this aspect of due diligence seriously and conduct it early and thoroughly.

Once an organization’s reputation is compromised, it is difficult to undo the damage. The earlier legal counsel become involved, the more likely organizations can mitigate any present and future risks.

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