How to Conduct Due Diligence When Acquiring a Small Business?
“Nobody wants to invest in a failing business”. The concept of relentless optimism doesn’t apply to the decision of buying a business; otherwise, the deals will never be profitable enough. Generally, whenever a business thinks of extrapolating its consumer base or extends its services it goes forward to sales and merger, and then considers to start by itself. For acquiring any business, any business owner or management needs to go through the entire list of assets, contracts, benefits, problems, and much more. Thus proper critical research is mandatory for making profitable and intelligent decisions against the risk involved. It may require a lot of time and financial commitment, but due diligence simplifies the entire process.
Due Diligence is required for Joint ventures, Mergers or Sales, IPO, Risk Management, Public or private financing, Financial statements, or annual reports.
Why is it so important?
It acquaints the decision-makers to go through every feature of business they should be aware of like contracts, obligations, litigations, or risks associated leaving not even a single factor overlooked.
Formal Requests of witnessing documents listed in due diligence can be made.
On analysis of the due diligence report, conclusions, and forecast related to potential turnover, revenue, cost of integration and overall ROI can be made.
Reverse diligence can be also carried out to analyze the buyer.
Key parts of a due diligence checklist:
- Regulatory issues, Litigation, and antitrust cases
- IT and IP concerns
- Data of outsourced personnel and employees along with availed benefits
- Product and services
- Client information
- Past, present, and future contracts for materials
- Environmental Impact
- Permits and licenses
- Financial Information and source of Revenue
- Establishment documents
- Physical assets and real estate
A deep dive
- A detailed description of the business should be given in Due diligence which should cover the location and history of the business, products, and services rendered, no of employees, Profit, and Loss statements, Balance sheets, assets lists, listing price, operational details, business valuation, etc. A seller’s requirement for confidentiality must also be taken care of.
- In the case of antitrust and regulatory information regarding the case/ property, purchases associated should be deeply inspected. A list of prior regulatory or antitrust issues should be taken care of along with the commerce filings. List of all pending litigations threatened litigations, unsatisfied judgments, injunctions, settlements, insurance policies, Regulatory policy clashes with bodies, and reviews of every board meeting should be given.
- In IT concerns the proper list of software- licensed, customized, and free; currently used should be provided by the seller. If any service is outsourced, it should also be informed along with the contract. The date of purchase and remaining life of the product should be given on paper along with the frequency on which maintenance is required. As with the IT tools and architecture is concerned, a plan in case of any threat, hack, intrusion, or disaster, a recovery plan should be present and provided.
- In the case of IP rights list of domestic and international patents, copyrights, trademarks should be provided. Measures taken to disclose trade secrets should also be discussed with the buyer. IP rights disclosure should also include work-for-hire agreements, patent clearing documents, relevant technical information, a summary of claims and threats, licensing revenue receipts, intervention agreements, and much more.
- All information of all the professionals who have been with the firm for the past 5 years should be presented along with their contracts of the binding document.
- For Insurance data, data of insurance claims for the past 3 years, insurance coverage which covers everything i.e. worker’s compensation, liability, D&O and E&O, Vehicle, IP, Errors, worker’s compensation, general liability, directors, etc.
- A proper list of information about the product and services rendered is given to the buyer along with those underways or are in development. The seller should be providing complaint summary, warranty claims, tests, evaluations, reports, product applications, current market share, major clients, profitability, and cost structure along with the nature of industry change to the buyer.
- Description of all the peers in the market with their strengths and weakness through market research conducted should be informed to the buyer. Current ad programs, marketing budgets, printing costs, campaign costs, and cost per lead should also be discussed with the potential buyer. Other relevant information includes a list of distribution channels, coordination protocols, scheduled unfilled orders, credit and purchasing policies, strategic partnerships or relationships, supplier data, and much more.
Lastly, in tax, returns for the past 3 years should be given in proof, to local, national, and international bodies with net and overall cash flow data. This data must also include tax liens if present along with audit reports. Sales tax, employment tax, undisclosed tax liabilities, detailed explanations, finance of debt, and equity should also be given.
Due Diligence plays a pivotal role when a firm goes for a merger or acquisition. Though the format of due diligence may be different, these sets of data are mandatory to decide the step.