Due diligence is generally considered an activity that takes place as part of the selling process. It might be wise to take a look at the business from a buyer’s perspective in performing due diligence as part of an annual review of the business. Performing due diligence does two things: (1) It provides a valuable assessment of the business by company management, and (2) It offers the company an accurate profile of itself, just in case the decision is made to sell, or an acquirer suddenly appears at the door.
This process, when performed by a serious acquirer, is generally broken down into five basic areas:
- Marketing due diligence
- Financial due diligence
- Legal due diligence
- Environmental due diligence
- Management/Employee due diligence
It has been said that many company officers/CEOs have never taken a look at the broad picture of their industry; in other words, they know their customers, but not their industry. For example, here are just a few questions concerning the market that due diligence will help answer:
- What is the size of the market?
- Who are the industry leaders?
- Does the product or service have a life cycle?
- Who are the customers/clients, and what is the relationship?
- What’s the downside and the upside of the product/service? What is the risk and potential?
Two important questions have to be answered before getting down to the basics of the financials: (1) Do the numbers really work? and (2) Are the seller’s claims supported by the figures? If the answer to both is yes, the following should be carefully reviewed:
- The accounts receivables and payables
- The financial statements as compared to the tax returns
- The inventory and all other physical assets
Are contracts and agreements current? Are products patented, if necessary? How about copyrights and trademarks? What is the current status of any litigation? Are there any possible law suits on the horizon? What would an astute attorney representing a buyer want to see and would it be acceptable? Using a Seller’s Disclosure will go a long way to limiting future liability.
Not too long ago this area would have been a non-issue. Not any more! Current governmental guidelines can levy responsibility regarding environmental issues that existed prior to the current occupancy or ownership of the real estate. Possible acquirers – and lenders – are really “gun-shy” about these types of problems – especially when it is the sale of a gas station or business that uses chemicals, solvents etc.
What employment agreements are in force? What family members are on the payroll? Who are the key people? In other words, who does what, why, and how much are they paid?
The company should have a clear program covering how their products are handled from raw material to “out the door.” Service companies should also have a program covering how services are delivered from initial customer contact through delivery of the services.
The question is, do you give your company a “physical” now, or do you wait until someone else does it for you – with a lot riding on the line? Completing due diligence with your broker prior to the listing of a business goes a long way in identifying potential problems in the future.