Conducting adequate due diligence is imperative to the future success - and longevity - of an acquiring company. Therefore, potential buyers need to take their time to be as thorough as possible in ensuring a sweeping and competent investigation.
There are numerous books of extreme length about how to conduct a proper due diligence inspection. Since you’re asking for a list, I’m concerned about your risk exposure, because a competent examination requires much more than simply running through a list. Therefore, I think it’s going to be most helpful by beginning with a brief explanation of the investigation’s purpose, as well as the risks you run with an incomplete due diligence inspection.
The central purpose of due diligence in connection with an acquisition is valuation and risk assessment. The three primary areas that are assessed for risk and valuation are legal, financial and operational.
Risks of Inadequate Due Diligence
Acquiring companies often find out too late that their investigation left a lot of rocks unturned. In my experience, the results of a weak investigation generally fall into the following categories: (1) unanticipated costly integration, and (2) inheriting considerable legal liabilities that weren’t uncovered. The result is paying too much for the target, which doesn’t quite have the value you believed it had.
Components of Adequate Due Diligence
The two primary components of a sound due diligence investigation are (1) document review, and (2) field work.
You certainly want to ensure that you retrieve all the documents you need in order to accurately assess the target’s value. However, it’s going to take much more than possessing boxes of seemingly endless files in order to be able to sufficiently assess the real value and risk exposure of the target business. You need to have superior organization and a robust team - including an experienced legal roster. It’s really impossible to overstate this last point.
- Field Work
I’d recommend that you begin your investigation by probing the backgrounds and reputations of key management, as well as the target’s general reputation in the industry with vendors, creditors and customers, and among staff.
- Document Review and Analysis
This entails making certain that you have all the documents you need for a thorough assessment of risk and valuation; and further, that the files are scrutinized for errors, omissions, and any other impairments. A meticulous examination of the records should also generate many questions that you follow up on both in writing and as part of the interviewing process.
Key Constituents of a Strong Due Diligence Team
A robust list of questions is as important as a comprehensive list of documents. Again, make sure you assemble a robust due diligence team and take your time to thoroughly complete the investigation. You can find a reliable, though basic, list of questions here. Your legal team will be able to provide you with a more substantial list of items and questions, but this will give you a sense of what’s partially entailed.
Your team should consist of the following experts:
- Business and Industry Professionals
- Marketing Professionals
- Human Resources
- Finance & Accounting
- Compliance/Risk Management/Insurance
- Tax Professionals
Here’s a pretty decent infographic from Bain & Co. that will help you visualize the overall process.
Since it’s ill-advised to contemplate a due diligence investigation as a do-it-yourself (DIY) project, I’m offering this list just as a small sampling of the types of records that are commonly requested in this effort. Please do not use this or any other information presented here as a substitute for legal advice; it’s not. Again, I urge you to seek an experienced attorney for the legal guidance you’ll need. You can also take a look atLawTrades for any additional information about acquisitions and due diligence you require.
Here’s the menu sample:
- Organizational Records (e.g., incorporation documents, structural/governance documents, jurisdictional qualifications/standing & status)
- Financial (e.g., liens/encumbrances, loans, notes, investments/holdings, real estate records such as deeds, leases, zoning variances/compliance, etc.)
- Regulatory Compliance Records (everything including anti-money laundering, foreign account tax compliance, privacy, supply chain, labor, OSHA, SEC, anti-corruption and bribery-notably the FCPA (Foreign Corrupt Practices Act))
- Employment Records (e.g., EEO and health & safety compliance, benefits, subcontractor agreements, confidentiality agreements, non competes, I-9 compliance)
- Insurance Policies (e.g., D&O, E&O policies)
- Legal (including past, existing and potential litigation - both by and against the company)
- Business (e.g., marketing strategies and procedures, customer lists, sales & distribution, purchase & sales orders, product & vendor contracts, production processes, R&D, operational controls/best practices, market position & SWOT assessment (strengths/weaknesses/opportunities/threats) as part of the market analysis)
- Intellectual Property (e.g., licenses, copyrights, registrations, filings - past, pending or contemplated)
- Management (e.g., compensation packages, employment contracts, benefits, management/shareholder agreements, stock options)
The core elements of your due diligence data trail will include legal opinions, memoranda and other written records. In order to competently execute the examination, your team will use manuals, checklists, notes, questionnaires and guidelines. At the risk of repeating myself, this work is usually spearheaded by a qualified legal team who will have available all the tools of the trade to assist you and your company through the investigation.
Due diligence can be disruptive to both the buyer and target company. It’s certainly time consuming, often costly, and always a monumental pain. At the same time, it’s about one of the most important things you can and really need to do properly.
Assembling the best team you can and an abundance of self-discipline are priorities. It’s both an exhaustive and exhausting process that demands complete attention and laser focus on the ultimate goal: to ensure that you’re truly getting what you paid for.
One other note I’d make is that part of your list should include a separate process devoted to cultural integration. I’ve found that the tendency during active acquisition is to give much lip service to those sensitivities, but the follow up often misses the mark. There’s a lot you can do to promote an easier transition for the collective staffs of both companies - requiring other lists and deeper discussion. Just want to make sure that this part isn’t overlooked since it’s probably one of the best things you can do to facilitate integration - and ultimately gain an even sharper competitive advantage (or at least not lose ground).