5 reasons why you should use a due diligence checklist when buying a business
When you’re buying a company, it’s important to do your due diligence. This means completing a thorough investigation of the company and its financials. A due diligence checklist can help you make sure that you don’t miss any important steps during your investigation. In this blog post, we’ll explain why a due diligence checklist is still important when buying a company, and we’ll give you some tips on how to use it effectively.
First and foremost let’s clarify when you need a due diligence checklist in the first place. Due diligence is necessary when buying a company, but it’s also important to do if you’re going through with any other major financial decision. Examples of this include investing in real estate or stocks and bonds, applying for a loan from the bank, or even taking out an insurance policy on your car. A due diligence checklist will help you go over all the important points for each of these decisions.
Now let’s move on to why a due diligence checklist is still important when buying a company. One big reason is that you can never be too sure about what you’re getting yourself into. Due diligence allows you to identify any potential risks or problems with the company before you finalize the purchase. This can save you a lot of time, money, and aggravation in the long run.
Another reason to use a due diligence checklist when buying a company is that it can help you get the best deal possible. By being knowledgeable about the business and its finances, you’ll be able to negotiate from a stronger position with the seller. A thorough due diligence checklist can also help make sure you’re not overpaying for a company that has been in decline or is losing money.
A third reason to use due diligence checklist when buying a company is that it protects against lawsuits and other legal issues that may occur after the purchase. Solid due diligence allows both parties to resolve any disputes before they escalate into costly litigation later on. If someone tries to sue you or your company after the purchase, having a well-done due diligence checklist as evidence of your good faith efforts will help your case.
Finally, using a due diligence checklist can help you get up to speed on the company quickly and efficiently. By taking the time to go through all the information ahead of time, you’ll be able to hit the ground running once you take over as CEO.
Now that we’ve covered why Due Diligence is important when buying a company, let’s move on to how it can be effectively used during your investigation – in other words during the due diligence process itself.
One tip is to use due diligence checklists from reputable sources such as those provided by law firms or other experts in this area of business. Going through these checklists will help you stay organized and ensure that everything gets done in a timely manner. Another tip is to make sure all your questions get answered before moving forward with any decisions or agreements on paper.
The Due Diligence Checklist should be completed during the Due Diligence process itself, which means it can be used as a checklist for Due Diligence. Due Diligence is important when buying a company, but it’s also important to do if you’re going through with any other major financial decision.
What areas should you look after during due diligence before buying a business?
Besides the company itself that you intend to buy there are a couple of areas to look for when you buy a business:
- Overall Due Diligence
- Financial Due Diligence
- Operational Due Diligence
- Due Diligence of Intellectual Property
- IT Due Diligence
Each of parts will have different aspects to look into and you must be aware of what is included in each category. Below we’ll give a brief overview of types of Due Diligence:
Financial Due Diligence – it’s money at the end of the day
During financial due diligence, you will inspect the financial statements of the business you want to buy. You’ll look into their income statements and balance sheets to assess if they are making money or not, whether there is enough cash flow for them to be sustainable, etc.
Most likely the company you are looking after has credit agreements with banks or other financial documents you need to dig in deeper.
Due Diligence of Intellectual Property – it’s all about the IPs
When you’re doing the due diligence of intellectual property (IP), you want to make sure that the company you’re buying has valid and enforceable Intellectual Property Rights (IPRs). This includes trademarks, copyrights, trade secrets, patents, etc. You’ll also want to check for any existing or pending litigation involving the IPRs of the company.
Legal due diligence
Before you can buy a business you have to go through some more boring stuff like legal documents. During legal due diligence, you’ll review all the contracts and agreements that the company has entered into, as well as any licenses or permits they may have. You’ll also want to make sure there are no pending lawsuits against the company.
The legal part of due diligence may even mean that you have to get in touch with both suppliers and customers to check material contracts, security agreements, consulting agreements or purchase agreements.
IT Due Diligence – your business is only as good as its IT infrastructure
When doing IT Due Diligence you’ll want to assess the overall IT infrastructure of the company. This includes reviewing the hardware and software they are using, as well as their network security measures. You’ll also want to make sure that all the data the company has is backed up and if it’s not, create a plan to do so.
Operational Due Diligence – is the company running smoothly or not?
During an operational Due Diligence, you’ll want to assess how well the business is being run. This includes looking at their staffing levels, customer satisfaction ratings, and any other metrics that might be important for your particular industry.
You might also check if the company is certified by external standards like ISO 9001 or similar. It’s also a good idea to check the internal controlling mechanisms as well as the company’s internal control procedures.
Organisational Due Diligence
Given that the company you looking after has more than a few employees, you must have a closer look at how the company is structured and organized. This includes looking into the management and operational structures, as well as the company’s HR policies.
Ask yourself these questions:
- Is the organizational structure solid for future growth?
- Is there an existing hierarchy of at least some teams and their respective managers?
- Are there enough motivated and experienced managers to run the company even if the current board team is gone?
- How complex are the products or services the company produces
- How long does it take to onboard new employees
All these questions and many more need to be answered during individual audits alongside a ser diligence process.
Key employees for an upcoming merger or acquisition
Nowadays some company acquisitions are merely done to acquire the workforce (aka the employees) itself. Even if you are not looking to find cheaper or better-trained labor you have to make sure that your acquisition target isn’t too much dependent on key employees leaving the company.
If you want to make sure whether the employees are willing to stay with the acquiring company, you can look at their length of employment and turnover ratio within a specific timeframe (e.g. last 12 months).
Another thing worth checking is if there are any key employees with a written employment agreement that would make the company liable for additional payments if they leave.
Competition Due Diligence – what about your competition?
If you’re buying a business, it’s also a good idea to do Due Diligence for your competition as well. You’ll want to know how strong your competition is, what their weaknesses are and if they are doing any Due Diligence for you.
You can get this information by looking at public filings (e.g. SEC filings), as well as through private investigations like interviewing customers or suppliers.
The whole process can seem daunting, but it’s important to remember that Due Diligence isn’t just about finding out what’s wrong with the company you’re buying. Due Diligence is also a way to find opportunities for growth and improvement in your own business.
Overall Due Diligence – all about looking at everything
The overall Due Diligence is a catch-all for all the different aspects of Due Diligence that we’ve mentioned so far. During an overall Due Diligence you’ll want to make sure that everything we’ve talked about checks out. You might even want to hire an external consultant to help with this process.
Tools to use during a due diligence
Besides a solid diligence checklist, you’ll probably need a few tools to help you along the due diligence process. Here are a few
- The checklist itself
- a virtual dataroom – sometimes also called a dealroom to dig deeper into the due diligence documents that are shared between you and the seller
- Software to track open questions and answers (which might be part of an online data room as well)
- Project management software
Negotiation after a due diligence
Just before finishing your due diligence process and sifting through all the due diligence documents, you’ll come to the point of deciding if the business is worth entering the next stage of the diligence process: Negotiation and finding a proper price for the company.
Your Due Diligence will probably have found a few aspects of the business that need to be fixed or changed – at least from your point of view. You can use this information in your negotiation with the seller, as well as pointing out opportunities for future growth and improvement.
Serious due diligence can take months – so make sure you follow a proven path and use a well-crafted due diligence checklist.