INTRODUCTION

Due diligence is the process of examining the details of a transaction to make sure it’s legal, and to fully apprise both the buyer and seller of as many facts in the deal as possible. When the deal satisfies both aspects of due diligence, the two parties can finalize and correctly price the transaction. It’s a process of verifying, investigating, and auditing a potential deal or investment opportunity to corroborate facts, financial information, and other pertinent data.


People and organizations perform due diligence in many areas, including the sales of securities, IPOs, private equity funding, and real estate. Financial advisors commonly practice due diligence as well. The most widespread use, and the main topic of this article, is in mergers and acquisitions (M&A).

DUE DILIGENCE REVIEW is a process, whereby an individual or an organization, seeks sufficient information about a business entity to reach an informed judgment as to its value for a specific purpose. Dictionary meaning of ‘Due’ is ‘Sufficient’ & ‘Diligence’ is ‘Persistent effort or work’.

Offers to purchase a business are usually dependent on the results of due diligence analysis. This includes reviewing all financial and legal records including anything else deemed material to the sale.

Sellers could also perform a due diligence analysis on the buyer which would help the seller to be aware of the buyer’s ability to purchase and of factors that could affect the purchased entity or the seller after the sale has been completed.

Due diligence is a way of preventing unnecessary harm to either party involved in a transaction. 

What Is Due Diligence in Business?

In business, due diligence is the process of making sure every aspect of a transaction is in order before it moves forward. When a company considers issuing an IPO, potential investors perform due diligence on that company to make sure it’s worth the investment. The term is sometimes used in the hiring process to verify that a candidate has the experience they claim

Due diligence in M&A can include not only looking at obvious details like financial stability, sales, real estate, and intellectual property, but also pending litigation, labor relations, environmental problems, and relationships with third parties.

History of Due Diligence

The term due diligence, as related to transactions, entered common usage as a result of the U.S. Securities Act of 1933, specifically section 11b3, which says that sellers of securities have to give investors enough information to make an informed decision before buying. In this situation, the term meant "required carefulness" or "reasonable care." Since then, the expression has spread to other areas and has found its most common use in mergers and acquisitions.

The Role of Due Diligence

With proper due diligence, all involved parties are educated, informed, and covered in a transaction, an arrangement, or any other kind of agreement. Think of it like homework: It should be completed before the close of a deal to provide a buyer with a guarantee of what it’s getting.

In M&A, due diligence helps buyers and sellers make informed decisions. The process validates the accuracy of the information presented, ensures that the transaction complies with the criteria laid out in the purchase agreement, verifies that the parties consider all benefits and risks, and allows the buyer to know what they are buying.

Due diligence increases the chances of a successful deal by uncovering major problems or assets that need to be addressed. Additionally, due diligence can lead to a more accurate pricing of the transaction. Without proper due diligence, unforeseen problems may arise after the deal closes. At that point, they fall on the buyer, which may not be able to address them through litigation.

Certainly, due diligence incurs upfront costs, but the outlay is justified because it provides buyers and sellers with peace of mind and a level of comfort with their expectations. Ultimately, it helps ensure the buyer and the seller are equally knowledgeable about the transaction.

SCOPE & OBJECTIVES

It is very much necessary that the scope of DUE DILIGENCE REVIEW is determined in consultation with the client. It is not confined to financial due diligence but extends to operational due diligence, market due diligence, technical due diligence, legal due diligence, systems due diligence, etc. all of which form an integral part of the overall due diligence exercise.

Generally, a comprehensive DUE DILIGENCE REVIEW is undertaken with the following objectives:

  1. To assess the commercial and technical feasibility, resource availability of the business and synergy between the organisation (acquirer & target).
  2. To ensure the compliance of necessary statutes and ascertain the liability in the event of non-compliance.
  3. To finalise the value of the acquisition or a financial investment.
  4. Look at tax position/structure and its implications
  5. Look for overvalued assets or under recorded liabilities, hidden assets or liabilities.
  6. Assess the quality of management and identifying key employees of the Target Company.
  7. To prepare a post-acquisition plan.
  8. Look into any other significant matters of interest to the acquirer.
  9. Provide value added information about the target’s business.

 

TYPES OF DUE DILIGENCE

Due diligence applies to many aspects of business. See how they’re used in the key areas listed below:

MERGERS & ACQUISITIONS

In an acquisition, a company buys another company (or even part of another company); a recent example is Amazon's purchase of Whole Foods. When two companies come together on equal terms, it’s a merger. In either case, due diligence helps companies do the following:

  • Make sure that all information reported by the seller is accurate.
  • Find and mitigate any risks.
  • Ensure compliance with legal and regulatory requirements.
  • Allow the deal to be priced based on facts, not assumptions.

Performing due diligence helps the buyer determine whether it actually will make the purchase and how much it should pay. The process may be voluntary in some cases and involuntary in others.

The concepts of soft and hard due diligence also come up within the M&A world. Hard due diligence is the traditional process described in this article. Soft due diligence focuses on culture fit and other elements related to how people work together. If the two cultures of the acquiring and target companies seem like they won’t combine well, then the companies may have to change personnel decisions, particularly with top executives and influential employees.

Steps involved in case of Due Diligence of Mergers &Aquisition

Before they can put up a company for sale, the sellers need to do their work — some of which is later used in the due diligence process. Key preliminary due diligence actions include the following:

  • Strategy planning and preparation
  • Exit planning (the seller determines how to transition out of the business once it’s sold)
  • Formal marketing of the sale of the business

Both buyers and sellers must sign nondisclosure agreements (NDAs) and confidentiality agreements along with — or, for some key people, before — the LOI. Then due diligence begins. The seller sends a confidential information memorandum (CIM), also called a deal book, which provides crucial information about the company.

One of the first steps is to establish a document exchange. Pre-internet, this required a team to visit (often multiple times) the seller’s location and physically handle documents. Much of this work can now be done via a secure online data repository. The parties can post documents and grant access to those who need to see them. They also have the luxury of accessing documents at any time from their own office. However, site visits are still important.

“The ability to go to an operation and actually meet and greet people is a good thing,” says Elson. “Going to an operation and sitting there, feeling it, seeing it, understanding how people come together is an important part of the process … you don’t conduct due diligence merely on the internet.”

During due diligence, you may repeat a number of steps if new information comes to light:

  • Analysis of the purpose of the project (i.e., if the deal still meets business goals)
  • Analysis of the financial business case
  • Review of key documents
  • Risk analysis
  • Analysis of offer price (which may be tweaked based on discovery)

The results of the due diligence process (which should be compiled in a final report) will indicate whether or not you should move forward with the deal. If you do, negotiation then takes place, and you can make a final offer.

After the close of the deal, the companies issue a final announcement regarding the transaction. From there, they begin integrating functions, staff, and operations.

 

SECURITIES SALES

The phrase due diligence was first used for securities sales. Specifically, securities sellers must disclose any material information they discover related to the securities that they plan to offer investors. If they fail to disclose such information, they are liable for criminal prosecution. Securities sellers research the offerings they are considering selling, the backers of the securities, the owners of the company, the performance history of the security, and other data in order to perform their analysis and uncover pertinent material information.

Steps involved in case of Due Diligence of Securities Sales

Due diligence is used mostly for securities, but it can also apply to debt. When investigating securities, financial advisors should look at the following areas (at a minimum):

  • Market capitalization (total value) of the company
  • Revenue, profit, and margin (investments, net income)
  • Competitors and industries
  • Valuation multiples (e.g., price-to-earnings ratio)
  • Management and share ownership
  • Balance sheet (bond ratings, dividends paid, debt-to-equity ratio)
  • Stock price history
  • Stock options and dilution possibilities (e.g., 10-Q and 10-K reports)
  • Expectations
  • Long- and short-term risks
  • The amount of stock that the executives own
  • Income and revenue estimates for the next two to three years
  • Any long-term trends that might affect the corporation
  • Details about partnerships, joint ventures, IP, and new merchandise/companies

While advisors may not be legally obligated to perform due diligence on funds they recommend, it's a smart move to preserve the portfolios of your clients.

IPOs

Before a company's IPO, attorneys, underwriters, and the company itself have to prove to the SEC/ SEBI that the declarations the company made when filing are true. Key employees and those in the C-suite answer questions about areas such as the business plan (including marketing), product development, intellectual property, and revenue projections, with an eye to finding possible pitfalls. Third parties (e.g., vendors and customers) may be interviewed, as well. Companies can also expect an audit of their records, from HR to finance to licenses to tax filings and more.

BANKING

Banking and financial services companies may perform due diligence on potential customers to make sure they are not involved in illegal activities that could bring legal action against the institution.

Enhanced Due Diligence

Due diligence is not always enough. In such cases, organizations perform enhanced due diligence, which is required when a potential banking customer poses a higher risk of being connected to money laundering, terrorist financing, or other financial crimes. A customer may run a higher risk due to their business activity, ownership structure, or anticipated or actual amount and types of transactions (this includes transactions that involve higher-risk jurisdictions).

In cases where enhanced due diligence is necessary, the bank should request the following information, both upon the creation of the account and on a recurring basis afterward:

  • Nature of the business
  • Purpose of the account and expected types of business transactions
  • Source of account funds and other assets
  • List of all individuals who have ownership or control over the account (e.g., beneficial owners, signatories, guarantors)
  • Type of businesses of all individuals with ownership or control over the account
  • Financial statements
  • Key business documents
  • References
  • Where the customer resides and the primary trade area
  • Where the business is located and the primary trade area
  • Proximity of the bank to the customer’s residence, place of business, and place of employment
  • Expectations of routine international transactions
  • Description of business operations, anticipated volume of transaction, and total sales
  • Major customers and suppliers
  • Explanations for any changes in account activity

The bank should also review the internet and news sources for negative mentions of the customer.

Simplified Due Diligence

Unlike enhanced due diligence, simplified due diligence means performing a less rigorous version of standard due diligence. The organization can implement simplified due diligence when the customer runs a very low risk for money laundering, terrorist financing, or other financial crimes. This term is more prevalent in the European Union and a few Asian countries than in the United States.

CONTINGENT DUE DILIGENCE

Contingent due diligence is a term used in real estate to designate one of the status periods before the deal is final. During the contingent due diligence phase, the buyer can terminate the deal without penalty (generally for any reason).

 

VENDOR DUE DILIGENCE

Vendor due diligence is the process that a private business undertakes when it is either being sold or when it’s assets are up for sale. Vendor due diligence is conducted at the request of the seller, and is usually managed by an independent third-party. The third-party produces a due diligence audit which reports on the financial stability of the company in review, which is available to potential investors.

 

THIRD PARTY DUE DILIGENCE

Third-party due diligence is the process a business undertakes when it is looking to outsource work to an external company, in order to understand the level of risk involved. This type of due diligence has become increasingly important in recent years due to the introduction of strict anti-bribery legislation, which requires companies to provide evidence that they have sufficient anti-bribery measures in place.

 

DUE DILIGENCE IN OTHERS AREAS OF BUSINESS

The term due diligence is also used by financial advisors and in private equity funding.

 

WHY DUE DILIGENCE IS IMPORTANT

The process of due diligence serves numerous functions that benefit both buyers and sellers in a merger or acquisition. These benefits include the following:

  • Allows a buyer to confirm financial, contract, customer, and other pertinent information about the seller
  • Paints a fuller picture of the scope of the transaction, including discovery of previously unknown problems and assets
  • Leads to more accurate pricing (the initial offer could rise or fall, depending on what due diligence uncovers) because decisions are better informed
  • Permits the buyer to back out of a deal if due diligence uncovers problems that are too big or complex to address
  • Creates greater awareness, clearer expectations, and increased comfort for the buyer and seller of what’s expected of them to close the deal
  • Reduces the knowledge gap between buyer and seller, leading to better (and better-informed) decisions

HOW CAN COMPANIES USE DUE DILIGENCE?

The questions raised during due diligence should drive further investigation.

Due diligence also protects shareholders by determining if the transaction makes sense in terms of valuation.

Once the companies complete their due diligence, the process will drive one of the following results for the proposed deal:

·         Repricing

·         Changing the terms or scope

·         Canceling

·         Moving forward as originally planned

A letter of intent (LOI) is a document that states the buyer and seller are negotiating a merger or acquisition but have not yet reached a final agreement. Most LOIs have a material adverse change (MAC) clause that allows the parties to change or terminate the deal if new information comes out.

 

 THE CHALLENGES OF DUE DILIGENCE

Due diligence poses a number of challenges. Working through these issues is essential to ensuring that the process reveals all connected information and the transaction is performed legally.

·         It can be difficult to ensure that the parties meet all applicable legal and regulatory requirements..

·         Buying a private company draws more scrutiny than buying a publicly traded company, as private companies haven't gone through the examination required for a public offering.

·         If the deal includes international components, companies must comply with the Foreign Corrupt Practices Act and international accounting standards.

·         Every deal is unique, so every process has to be customized. This is even more complicated with the different types of M&A structures — for example, a stock transaction versus cash or an acqui-hire (i.e., buying a company to gain key personnel).

·         Sellers may not be ready to step aside after you complete the deal. This is hard to plan for, and due diligence can’t uncover it.

·         It may take 12 to 16 months for a certified exit planning advisor to prepare a transition plan.

·         Sellers may not start preparing information soon enough. It should happen when the company is being shopped around, not after the deal is signed. Deals often fail due to inadequate preparation and transition planning.

·         Companies must keep on top of changing regulations.

·         Sellers may be reticent to provide all information requested by the buyer, especially if it’s negative and may impact the final price, or if it takes lot of time to gather.

 

HOW LONG DOES DUE DILIGENCE TAKE?

While the LOI will delineate a time frame for due diligence, the general consensus is 30-60 days, but each merger or acquisition is different. Due diligence might run longer or shorter; the benchmark time frame exists to ensure that the due diligence process doesn’t become a sprawling, unending monster with no end in sight.

Consider the following when setting a timeline:

·         The complexity of the deal (e.g., how many subsidiaries does the acquired company have?)

·         What business (industry and vertical) is the acquired company in?

·         How large is the target company?

·         What kind of merger or acquisition is it?

·         Are any international properties involved in the deal?

·         The legal portion of the process can take 10-20 percent of your time and effort, and other portions take up the remaining 80-90 percent.

 

WHO CAN CONDUCT DUE DILIGENCE?

Due diligence is a demanding, high-pressure process that requires a lot of skill and expertise. The buyer is the primary responsible party, but they can bring in third-party advisors for support (companies with a lot of experience may perform the entire process in-house). External consultants could range from a single person for a small deal to a vast team for a multinational corporation. Regardless of the size of the buyer and the advisory team, the buyer should try to engage both internal and external experts to help them evaluate the deal (based on available funds). These experts should include the following:

·         M&A attorneys (for smaller deals, using an outside expert to lead the process allows the buyer and seller to focus on running their existing businesses)

·         Attorneys and experts in common fields, such as labor

·         Attorneys and experts in fields specific to the transaction (e.g., environmental authorities for the purchase of a oil spill cleanup company)

·         Accountants, including CAs , CPAs

·         Bankers

·         PMOs

·         Analysts

·         MBAs

·         Limited partners

·         VCs (for larger deals, if outside funding is needed to complete the deal)

·         Specialized consultants

METHODOLOGY

Methodology of DUE DILIGENCE REVIEW will depend upon the needs of the client, nature of review and time available. Hence, in any DUE DILIGENCE REVIEW, one will have to follow the steps listed below:

  1. Understand the needs of the client and decide the scope and objective accordingly;
  2. Preparation of list of information to be obtained from the client, which is necessary for carrying out DUE DILIGENCE REVIEW;
  3. Periodically hold review meetings with the team to ascertain the status of the DUE DILIGENCE REVIEW and further actions to be taken.

 

QUESTIONS TO ASK WITH A DUE DILIGENCE CHECKLIST

A long list of documents and correspondence from the company you wish to buy is not always enough. You must ask questions about the sale or the business. You might also need answers the documents don't offer.

·         Why are you selling the business?

You must ask this question before buying a business. If a seller doesn't have a good answer, it's a red flag. Most often, the business is being sold to raise funds for another business venture, divorce, estate tax, or retirement. Some are sold because of poor business practices or operating at a loss.

·         Have you attempted to sell before?

Sellers are reluctant to tell about failed sales. However, it might shed light on the company's underperformance.

·         Do you have a business plan?

A business plan is important to see how a business operates. Without one, must find out on your own. You can also use this document to compare projections to actual sales.

·         How easily can competitors enter or leave the market?

This question helps you find out how hard or easy it is to start the business. If competitors leave and enter freely, you might be able to start a project on your own.

·         How complex is the business model?

Every business has many moving parts. If there are too many subsidiaries or the model is too complex, managing it could be difficult.

·         Do you have an organizational chart?

An organizational chart shows you the departments within a company. It lets you see which managers deal with certain parts of the organization. A legal organizational chart helps you see subsidiaries, incorporations, and minority and majority investors hidden within the company.

·         What is your geographic structure?

If the organization operates in many regions, knowing the geographic structure is important. This shows how regions are carved up. In addition, it shows if there are enough sales, marketing, and distribution to support each region. If not, you can see where to improve from within.

·         Have there been any other acquisitions?

Knowing if there have been any other sales of companies in the industry lets you see trends. If there's a period of consolidation, this might affect the price you're willing to pay.

·         Do you have an online data room?

Online data rooms allow you to find the information you want quickly and easily. A good seller will make this room available to you as soon as you start negotiations. Quality data rooms make it easy to search via an index, table of contents, or search bar. If possible, you should be allowed to print documents.

·         What is on your disclosure schedule?

Anything not covered in the due diligence checklist must be included on a disclosure schedule. This document should make sure everything is covered. If something isn't, you can add it to your list of demands.

DUE DILIGENCE CHECKLIST: 

A due diligence checklist is an organized way to analyze a company that you are acquiring through sale, merger, or another method

What Is a Due Diligence Checklist?

A due diligence checklist is an organized way to analyze a company that you are acquiring through sale, merger, or another method. By following this checklist, you can learn about a company's assets, liabilities, contracts, benefits, and potential problems. Due diligence checklists are usually arranged in a basic format. However, they can be changed to fit different industries.

A due diligence checklist is also used for:

  • Preparing an audited financial statement or annual report
  • A public or private financing transaction
  • Major bank financing
  • A joint venture
  • An initial public offering (IPO)
  • General risk management

Why Is a Due Diligence Checklist Important?

The main reason you need a due diligence checklist is to make sure you don't overlook anything when acquiring a business. Having a due diligence checklist allows you to see what obligations, liabilities, problematic contracts, intellectual property issues, and litigation risks you're assuming. Most of the documents and information on your due diligence checklist is available on request. Once you have the information, it's up to you to analyze it and decide whether it's a good investment.

Another reason a due diligence checklist is important is that the buyer needs to know if the company is a good fit for its business. If the selling company provides a service the buyer doesn't, it becomes beneficial. It also provides a way to measure the length and cost of integration, as well as potential revenue.

Company sales, mergers, and acquisitions should all follow the same checklist to avoid unforeseen issues. Sellers might also create a reverse diligence checklist to analyze the buyer.

What Shouldone Have Due Diligence Checklist?

Most due diligence checklists involve 19 categories about a company:

  • Antitrust and Regulatory Issues
    • Any potential antitrust issues as a result of the purchase.
    • A list of any prior regulatory or antitrust issues.
    • A list of Statutory filings and Compliance
  • Information Technology Concerns
    • A list of software used by the company.
    • A list of software licenses bought to analyze other companies.
    • The current system usage and age of equipment.
    • Outsourcing agreements with IT companies.
    • The software's level of customization.
    • A list of interfaces that link systems together.
    • An analysis of the system. Legacy systems often need maintenance. From this analysis, you can choose to keep the current system or replace it.
    • An outline of a disaster recovery plan should systems crash or become damaged.
  • Publicity
    • Articles and press releases about the company within the last three years.
  • Outsourced Professionals
    • A list of all independent professionals that have worked with the company within the past five years. This includes accountants, lawyers, and consultants.
  • Insurance Coverage
    • A copy of insurance claims over the past three years.
    • A schedule and copy of the company's insurance coverage, such as:
      • Worker's compensation
      • General liability
      • Personal and property
      • Directors and officers
      • Errors and omissions
      • Key-man
      • Product Liability
      • D&O
      • E&O
      • Vehicle
      • Intellectual Property

 

  • Litigation
    • A list of all pending litigation.
    • Descriptions of threatened litigation.
    • A list of unsatisfied judgments.
    • Documents about injunctions or settlements.
    • Copies of insurance policies that protect against litigation.
    • History of problems with regulatory bodies such as the SEC or IRS.
    • A review of all board minutes, shareholder minutes, and audit minutes.
  • Product and Services
    • Lists of products and services offered.
    • Lists of products and services in development.
    • Correspondence and documents related to regulatory approval of product line.
    • Summary of complaints.
    • Summary of warranty claims.
    • Tests, evaluations, studies, and surveys about products or services under development.
    • A list of major customers and product applications.
    • Current market share values.
    • Profitability and cost structure, including:
      • Expense trends over the past five years.
      • Questionable expenses that you can cut.
      • Employee loans. This might include pay advances or long-term loans.
      • Fixed assets. 
        • If a company owns many fixed assets, it could show a reactive approach to market trends.
        • Valuation, inspection, maintenance, utilization, and replacement rate are all topics to know about fixed assets.
    • Speed and nature of change within the industry.
  • Customer Information
    • List and description of competitors, including strengths, weaknesses, market position, and basis of competition.
    • Current ad programs, marketing budgets, and printed marketing materials.
    • Research on ways to get new business.
    • A list of distribution channels, marketing opportunities, and marketing risks.
    • Surveys and market research on company products.
    • A comparative analysis.
      • This shows how the company's marketing efforts stack up against competitors.
      • It should also show the company's dedication to creating a brand.
    • A list of coordination protocols between the sales and marketing departments.
    • A schedule of the company's 12 to 20 largest customers, as well as sales within the last two years for each.
    • Issues about keeping customers after the sale.
    • A description of the company's credit policies.
    • A description of the company's purchasing policies.
    • Supply and service agreements.
    • A schedule of unfilled orders.
    • A list and explanation of any major customers lost within the past two years.
    • A list of strategic relationships or partnerships.
    • Revenue listed by customer
    • A list of the top 10 suppliers, as well as business deals within the past two years.
    • A sales force productivity model that outlines:
      • Plans for new hires
      • Quota average
      • Sales cycle
      • Compensation and commission
      • Organization
      • Productivity
      • Skills match
  • Tax Information
    • Income Tax & Indirect Tax returns for the past three years, including net loss or profit.
    • A list of any tax liens.
    • State sales tax returns for the last three years.
    • Excise tax filings for three years.
    • Audit reports.
    • Employment tax filings for past three years.
      • This shows if the company pays a lump sum or quarterly taxes.
      • You can also see if the company is paying the correct amount in taxes.
    • Tax settlement documents over the past three years.
    • Detailed explanations of general accounting principles.
    • A schedule of financing for debt and equity.
    • A list of undisclosed tax liabilities.
  • Materials Contracts
    • Monthly manufacturing yields.
    • Agreements and relationships with any subsidiaries, partnerships, or joint ventures.
    • Copies of contracts between the company and directors, officers, affiliates, and minimum 5 percent shareholders.
    • Loan agreements including promissory notes, financing details, and lines of credit.
    • All nondisclosure and noncompete agreements.
    • A list of mortgages, collateral pledges, indentures, and security agreements.
    • Installment sales agreements.
    • Guarantees involving the company on any level.
    • Copies of quote, invoice, purchase, and warranty forms.
    • Distribution, sales, marketing, and supply agreements.
    • Contracts, transcripts, or letters of divestitures from any merger or acquisition within the past five years.
    • Options and stock purchase agreements affecting company operations.
    • Off-balance sheet liabilities.
    • Explanation of supply chain and supply restrictions.
    • Transportation costs.
    • A list of inventory systems to track incoming and outgoing goods and find obsolete goods.
    • Power of attorney agreements.
    • Exclusivity agreements.
    • Franchise agreements.
    • Indemnification agreements.
  • Licenses and Permits
    • Copies of centre, state, and local  governmentlicenses, permits, and consent forms.
    • Any documents about proceedings with a regulatory agency.
  • Environmental Issues
    • A list describing or identifying any environmental liabilities or contingencies.
    • A list of hazardous materials used in production.
    • A list of any superfund exposure.
    • Copies of notices and filings with the Environmental Protection Agency (EPA).
    • A list of all environmental investigations and pending litigation.
    • Environmental audits for each company property.
    • A description of company disposal methods for hazardous materials, recyclables, etc.
    • A list of terminated licenses or permits.
    • Costs for environmental compliance.
  • Real Estate
    • Listings of all owned or leased property and locations.
    • Copies of deeds, mortgages, real estate leases, title policies, and zoning approvals.
  • Physical Assets
    • A list of leased equipment.
    • A list of major equipment sales and purchases over the past three years.
    • A schedule of fixed assets with locations.
  • Intellectual Property (Trade Secrets, CopyrightsPatentsTrademarks)
    • A list of foreign and domestic patent applications.
    • A list of copyrights.
    • A list of trademarks and trade names both domestic and abroad.
    • A description of methods used to protect trade secrets.
    • Descriptions of all technical information within the company.
    • Patent clearance documents.
    • Work-for-hire agreements.
    • Summary of claims or threatened claims on intellectual property.
    • Copies of all consulting agreements, invention agreements, and licenses of intellectual property to and from the company.
    • A list of all licensing revenue and expenses.
  • Employees and Benefits
    • Copies of stock purchase and stock option benefits for employees.
    • Worker's compensation claims history.
    • Unemployment claims history.
    • List of employees and their positions, current salaries, years of service, and total compensation over the past three years.
    • An explanation of the company's salary philosophy.
    • Pay history and pay freeze information, which helps you decide if current employees will expect a raise soon.
    • All nondisclosure, noncompete, and nonsolicitation agreements between employees and company.
    • Resumes, history, and experience of key employees such as senior level management.
    • A list of union affiliations and contracts.
    • List and description of all employee health and welfare insurance policies.
    • Descriptions of any labor disputes, arbitration, or grievances settled or outstanding over the past three years.
    • Copies of collective bargaining agreements.
    • A list of any officers in criminal or civil litigation.
    • Actuarial reports for the past three years.
    • Layoff and severance package information.
    • A list of harassment, wrongful termination, and discrimination disputes within the past three years.
    • A copy of the employee handbook including policies on vacation, sick days, benefits, holidays, and paid leave. This allows you to compare your current situation with others in the industry.
    • Turnover data for the past two years.
    • Documents on pension plan funding and distributions.
    • Copies of all Occupational Safety and Health Administration (OSHA) examinations.
    • The results of formal and informal employee surveys.
  • Organization and Good Standing of Company
    • The Articles of Incorporation and any amendments.
    • A list of company bylaws and amendments.
    • A list of company assumed names.
    • A list of all states or countries where the company does business, has employees, or owns/leases an asset.
    • Annual reports for the last three years.
    • A copy of the company's minute book.
    • An organizational chart.
    • A list of all shareholders and percentages owned.
    • Active status reports in the state of incorporation over the past three years.
    • Agreements on voting trusts, subscriptions, puts, calls, options, and convertible securities.
  • Financial Information
    • Audited financial statements (cash flow, balance sheet, income statement, footnotes) for the last three years, including an auditor's report and quarterly and annual statements.
    • Auditor's correspondence for the past five years. These are letters sent to management that outline areas to improve profits and efficiency.
    • Unaudited financial statements for comparison.
    • Company credit report.
    • A schedule of accounts receivable
    • A schedule of accounts payable. Check these for any overdue or unpaid accounts that might impact profit.
    • An aging schedule of accounts payable and accounts receivable.
    • A list of outstanding debt.
      • Search for any clauses that increase debt if a company is sold.
      • Scan for any related parties that have loaned money to the company. This includes manager, investors, and shareholders.
    • A list of unrecorded liabilities, which you usually find when interviewing the seller or employees.
    • A list of collateral for debt.
    • A schedule of depreciation and amortization methods over the past five years.
    • Analysis of gross margins.
    • Analysis of fixed and variable expenses.
    • A list of the company's internal control procedures.
    • A list of assets and liabilities.
    • A schedule of inventory.
    • Projections, capital budgets, and strategic plans.
      • Projections should include revenue by product type, customer, and channel.
      • Projections should also include all financial statements such as a balance sheet, cash flow statement, and cash-on-hand.
      • A list of growth drivers and possible clients and customers.
      • Industry and company pricing plans.
      • Analysis of projected expenditures and depreciation.
      • Any perceived risk in foreign markets such as inflation, political strife, and exchange rates.
    • The general ledger.
    • Analyst reports.
    • Breakdown of sales and gross profits by geography, channel, and product type
    • Planned projection vs. actual sales chart.
    • Capital structure.
      • Current shares outstanding.
      • A list of all stockholders with options, warrants, and notes.
    • A list of non-operational expenses. Many companies put operating expenses in this category to pad their earnings.
    • Public filings. If the company is publicly traded, Dtock Exchange , SEBI Compliances
  • Revenue Streams
    • Recurring revenue stream. This is a key value driver from the company. It shows loyal customers and how much they bring to the business.
    • Backlog. Creating a monthly backlog of the past year shows true revenue. It also shows decreasing or increasing revenue trends.
    • Pricing philosophy. This lets you know how the company prices its goods or services.
    • Estimating philosophy. If the company has a special order, it should have an estimate department. Analyzing this provides you with a detailed list of profit or loss.

With this comprehensive list, you leave nothing to chance. It covers all the company's major operations, leaving you with detailed, unbiased information.

RISK MANAGEMENT

The auditors carrying out DUE DILIGENCE REVIEW is exposed to an inherent risk and has to face financial indemnification of the consequential loss, if any. To mitigate the risk involved, the following should be ensured:

  1. Proper understanding of the objective of the assignment before accepting the assignment and deciding the scope.
  2. Review of other DUE DILIGENCE REVIEW reports, collect the copy of the same from the client and hold meetings with the other reviewers.
  3. Disclose the scope and limitations of the assignment in the DUE DILIGENCE REVIEW Report.

UNDERTAKING FROM THE TARGET COMPANY

As stated earlier, the auditors should take undertakings from the management of the Target Company to avoid risk. The undertaking should normally cover the following:

  1. Titles & ownership.
  2. Various Governments consents/licenses.
  3. Correctness and completeness of all information supplied.
  4. Product/service warranties, damages and other claims.
  5. Contingent liabilities.
  6. Recoverability of all current assets.
  7. Registration of Intellectual properties.
  8. Employee benefit plans.
  9. Litigation/appeals, etc.
  10. Non-contravention of regulation, loan covenants, contracts terms, etc.

CONCLUSION

Due diligence of a company is usually performed before business sale, private equity investment, bank loan funding, etc., In the due diligence process, the financial, legal and compliance aspects of the company are usually reviewed and documented.

A due diligence checklist is an organized way to analyze a company that you are acquiring through sale, merger, or another method. By following this checklist, you can learn about a company's assets, liabilities, contracts, benefits, and potential problems.

Certainly, due diligence incurs upfront costs, but the outlay is justified because it provides buyers and sellers with peace of mind and a level of comfort with their expectations. Ultimately, it helps ensure the buyer and the seller are equally knowledgeable about the transaction.