due diligence checklist

Due Diligence Checklist: A Comprehensive Guide

What is a Due Diligence & Due Diligence Checklist?

When you plan to buy a company, you want to be sure you fully understand what it is you are buying, and its value. The process that underpins that is M&A due diligence.

Due diligence is a painstaking process involving gathering information of different types – financial, commercial, legal and more – as a stage in the stock purchase procedure, whether you will be the sole buyer or are undertaking a joint venture. You then use that to take a deep dive into the nuts and bolts of the business, and verify things including assets and liabilities, current value and future potential.

There are many components involved in comprehensive due diligence. The best way to keep track of them, and to make sure you don’t overlook anything, is to use a due diligence checklist. It provides a handy template to keep you on course.

This isn’t just a paperwork or box-ticking exercise; this process is key to the success of any business venture. The seller might tell you something about the business that they believe to be true; due diligence will confirm or refute their assertion. Taking things at face value can be a costly exercise.

A due diligence checklist details the documents you need to see and the tasks you need to complete in order to thoroughly assess a target company. It will log what has been done and highlight what is outstanding so you can chase things up and make sure nothing is overlooked. All this will allow you to make an informed decision and put together a well-considered deal based on an accurate valuation. Although to be fair, it’s likely to be members of your deal team – including your accountant and lawyer – who do most of the work.

Why is due diligence important?

Due diligence is important because it shines a light into all the corners and cubby holes of a business, and any subsidiaries it might have. It uncovers financial issues such as outstanding debts and unpaid taxes. It reveals unsettled legal issues, such as claims against the company. It exposes people issues, whether they be staff, shareholders, suppliers or clients. And it presents market information that allows you to see the true potential for growth.

Due diligence allows you to make an informed decision as to whether to continue with the purchase, and also how much you should be paying for the business.

Who can help do a due diligence report?

Carrying out due diligence on any target company is complex and requires a spread of knowledge and experience that one person is unlikely to possess. For best results, tap into the network of help available to you.

The areas to look at are finance, legal, operational structure, employees, marketing, commercial, real estate and assets, and IT systems and digital security.

The first people to call on are members of your deal team. That should allow you to cover finance (your accountant) and legal (your solicitor). If you have a human resources (HR) expert on the team, they can cover employees. When it comes to covering other areas, what subjects do you have knowledge and expertise in? Have you a management team who can step up for, say, IT systems and digital security? If you still have knowledge gaps, look at hiring an expert to handle the due diligence process. Don’t skimp here; it could cost you dearly.

Your due diligence checklist

As we mentioned above, the areas to look at are finance, legal, operational structure, employees, marketing, commercial, real estate and assets, and IT systems and digital security.

Finances

Discuss financial documents crucial for assessing a company’s fiscal health and stability.

Financial due diligence allows you to do a complete financial health check of a target company over a number of years. Financial statements provide a historical view as well as the current picture.

Key documents include:

  • balance sheets, to see assets and liabilities
  • income statements to see income and expenditure
  • cash flow statements, to see how cash moves through the business
  • VAT and other tax returns and filings
  • audited accounts
  • annual reports

Aim to get a full picture through analysis of figures, including ratio analysis (for example, liquidity ratios) and identification of trends. Remember, cash flow is the lifeblood of a company so make sure it’s healthy. Also, make sure tax filings are up to date.

You also want stockholders/shareholder details, prepared forecasts and budgets, and liabilities.

Legal

Legal due diligence aims to establish that the business is operating lawfully and is compliant with applicable regulations. It also ensures you will be aware of potential or actual risks, liabilities and obligations.

Key documents include:

  • articles of association/articles of incorporation
  • shareholder agreement(s)
  • partnership agreements
  • any necessary occupational permits or licences
  • health and safety documentation
  • all material contracts, including supplier and customer contracts
  • insurance policies, including any claims made
  • previous or outstanding legal cases
  • information relating to intellectual property (IP) assets
  • documentation related to compliance with environmental regulations
  • documentation related to compliance with data protection laws

Regulatory compliance and legal compliance are important issues; make sure you can be confident the company is in good standing.

Operational structure

Operational due diligence looks at how the business functions on a day-to-day basis. It examines what the business offers and how it provides it, scrutinising internal processes and systems, and external relationships and dependencies.

Key areas to understand include:

  • the fundamental business offerings: products and services
  • the production process: machinery, capacity, training
  • the sales process: pricing, invoicing, profit margins and percentages
  • workflows and processes: this should be looked at for all areas, to identify things including efficiencies, redundancies and bottlenecks
  • the supply chain: suppliers, stock control distribution channels, sellers
  • machinery and technology: physical assets, IT equipment and software

This process should highlight internal strengths and weaknesses, and external opportunities and threats that might impact the business.

Employees

It’s essential you understand not only the number of people on the payroll, but what they do, how they are rewarded, and what contracts, policies and procedures are in place. You might also want to consider any relationship staff members have with the seller.

Key documents to look at include:

  • organizational chart, showing the structure of the company
  • employee handbooks, setting out procedures and policies (e.g. sickness and absence)
  • list of employees, plus any contractors, freelancers or others routinely used
  • contracts of employment
  • pay, employee benefits, and the review procedures
  • disciplinary proceedings
  • staff grievances and claims for compensation

Well-trained and experienced employees are an asset to any business. Understanding the corporate structure, what individuals contribute, worker’s compensation, including pension plans and stock options, and the terms on which they are employed helps you when it comes to making decisions about workforce.

Marketing

Marketing due diligence can cover a broad spectrum, including marketing activities, advertising campaigns, social media presence, brand awareness, and customer opinion. It can give you a good insight into how the business communicates with the wider world and the kind of relationship it has with customers and prospects.

Things to look at include:

  • marketing strategy and budget
  • measurements such as KPIs used to evaluate success
  • published materials, such as press releases
  • the connection between marketing spend and revenue growth
  • sales share per sales channel

It’s a good idea to find out how a business markets itself and its products, and to evaluate the success of those activities. It can provide insight into what might work for you.

Commercial

Commercial due diligence seeks to establish the commercial viability of a company and to offer an understanding into where it sits in the current market, what the competition looks like, and what are the prospects for future growth.

Things to evaluate include:

  • market size, market trends, growth rates, segmentation
  • market share
  • key competitors, and competitive advantage
  • customer contracts, loyalty, satisfaction, and concentration
  • revenue sources and streams, activity and potential for upselling and cross-selling
  • potential new markets

No area of due diligence exists in a vacuum and this is no exception. Activity here ties back to other areas, including marketing.

Real Estate and Asset

Present documents related to property ownership, asset valuation, and inventory.

Depending on the nature of the business there might be very little to look at here, or a great deal. Digital businesses are often light on tangible assets; a manufacturing or haulage company is likely to own a lot. This affects valuation.

Property

We’ll focus on three separate areas: property, tangible assets, and intangible assets.

If the property is rented, you need to know:

  • details of leases/rent
  • the condition the property is in (get a survey done and record the condition at the time you take over the lease)
  • running costs (e.g. utilities)

If the property is owned, you need to know:

  • details of any outstanding mortgage or other loans using the property as collateral
  • the value of the property
  • the condition the property is in (get a survey done)
  • rental income from any property owned and rented out
  • running costs (e.g. utilities)

Depending on the nature of the business, you might also want to conduct an environmental/health and safety assessment on the site as a whole, to understand any potential risks and associated costs, and confirm regulatory compliance.

Tangible assets

You need to know:

  • what physical assets (e.g. vehicles, machinery, stock, work in progress) are owned
  • the value of those assets
  • details of any leases, loans or liens outstanding
  • the condition of the assets
  • whether stock is saleable
  • maintenance and running costs

Intangible assets

You need to know about:

  • intellectual property rights, e.g. trade secrets, patents, copyrights
  • licensing agreements
  • customer lists
  • research and development
  • if there are any claims or litigation in progress against any of those items
  • goodwill
  • brand equity

This area of due diligence is key, not only so you don’t, for example, unwittingly buy a building with structural problems or machinery that doesn’t work properly, but also because you might be able to leverage some or all of these items when it comes to funding the purchase of the business.

IT Systems and Digital Security

Businesses of all types rely on IT infrastructure and systems, and conducting due diligence in this area is crucial. As well as the physical tech, issues such as data security and the cybersecurity measures that are in place need to be looked at.

You need to know:

  • what hardware and software is owned and used, and how old it is
  • what data is stored, whether it is compliant with data protection regulations, and how it is safeguarded
  • if the system is vulnerable to cybersecurity attack
  • what disaster recovery and business continuity plans exist
  • whether software licences, contracts and agreements are up to date
  • details of employee training, past and ongoing

It’s essential that all companies keep their own and third-party data secure and protect themselves from potentially disruptive cyberattacks. Understanding the strengths and vulnerabilities allows you to understand both what you are buying and any steps you will need to take to ensure the business and its data is secure.

When Due Diligence Documents Should be Provided to the Buyer?

As the potential buyer of the business, you should expect to be asked to sign an NDA, and also to have signed heads of terms, before you gain access to this kind of information. It might be provided piecemeal or via a data room.

You might be lucky and be dealing with a seller who has prepared most of this kind of information in advance – but be prepared to have to dig for what you want to know. And be persistent; this is all information you need access to and that is it reasonable to ask to see. If a seller is cagey or unhelpful, that can tell you a lot about the business as well as the individual who owns it.

After you have been through the process, you can create a template for use with any further acquisitions.

How to Collect and Share Due Diligence Documents

While gathering the data necessary for thorough due diligence gives you a deep understanding of the target business, collating, tracking and sharing that data can be tricky.

Checklists and spreadsheets can be useful, and for digital documents you might want to effectively set up a data room and share them via for example, OneDrive. If you want your team to be able to edit checklists, Google Docs might be useful. Other options are available, so use whatever suits you, the seller and your team. This is a collaborative process, after all.

Due diligence provides data that can directly affect sale and purchase agreements. If you discover something of concern, for example to do with financial performance, you might want to include a warranty or indemnity, or make amendments to the purchase price or repayment schedule.

Talk to experts

Completing a thorough due diligence process is an essential step if you are looking to buy a business. As well as direct help from experts such as an accountant and a law firm, advice from people who have undergone the business-buying process – some of them, many times – can be invaluable. Talk to the experts at Dealmakers for insights, advice, and access to a world of experience in buying a business.

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