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What is due diligence?
Due Diligence Approach
Financial due diligence
Cash Flow (Financial) due diligence
Marketing due diligence
Legal due diligence
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 What is due diligence?
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Due diligence is the process of finding out undisclosed information and confirming that the information provided is more or less accurate. For a business buyer, it is the process of working through all the details provided to you but the business.
During the due diligence phase the buyer has to access to all the businesses books, financials and records. The due diligence phase provides you with a window to determine if the information provided to you is accurate. The process can take several days and sometimes up to a month as it is broad and must include financials, marketing and strategy amongst other things. Financial due diligence includes business valuation , identifying undisclosed liabilities and a lot more.
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Due Diligence Approach
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Due-diligence is the process of systematically evaluating the target company’s documents and other artefacts. If significant discrepancies are found it can result in being a deal breaker or result in the deal being re-negotiated.
Overall due diligence process can be classified in the following categories:
• Management due diligence
• Legal due diligence
• Financial due diligence
• Marketing due diligence
• Operational due diligence
Information required within each category can be acquired through interviews or documents. The person conducting the due-diligence may need to contact the target businesses lawyers, bankers, accountants, clients and suppliers for details about the business.
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Financial due diligence
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Financial due diligence requires you to look at all the financial health of the company. Financial due diligence provides the investor or acquirer information on the debt of the company, capacity to expand and more. Understanding the capital structure of the company is critical. Too much debt, poor Cashflow is some factor that can prevent growth and sustainability of the company.
Typically financial due diligence involves review the following documents:
• All published financial statements for the last 4 to 5 years which includes balance sheets, income statements and cashflow statements. This includes interim financial statements for the current quarter.
• All tax returns and tax payment schedules
• Appraisals on tangible assets including real estate owned by the business
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Cash Flow (Financial) Due Diligence
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Cashflow is the amount of cash being generated or spent during a specific period of time. It is the change in cash position or in the cash account due to revenue, expenses, operating costs and investments. Cashflow is typically impacted by:
• Accounts Receivable
• Accounts Payable
• Capital Expenditures
• Debt Servicing
• Tax Payments and other timing issues
Managing Cashflow is of paramount importance to operating a business on day to day basis. Accounting rules that govern the creation of financial statements are used to measure profit and loss. Therefore Balance Sheets and Income Statements do not provide an accurate and timely view of a company’s cash position.
Not managing cash flow can result in a cash crisis. For example, if cash is blocked in accounts receivables and investments, a company can find itself in a cash crisis even though the balance sheet is healthy.
Cash flow can be classified as:
• Operational cash flow
• Investment cash flow
• Financing cashflow
A Cashflow statement is a financial statement that shows companies incoming and outgoing cash for a specific duration. When buying a business, studying the companies cashflow statements plays an important role and must be completed during the due-diligence process.
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Marketing due diligence
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Marketing due diligence involves the review of the overall marketing strategy and marketing plan of the business being acquired. Typically a summary of the marketing plan is provided in the investment proposal.
During the due diligence process the investor or the acquirer must review the underlying market research including the size of the market, market segmentation, competitive pressures, threat of new entrants into the market, threat from substitutes and more. It is important to understand the overall size of the market the business operates in, the size of the market and more. Reports provided by external agencies provide significant credibility to the marketing plan.
• Marketing plan and marketing strategy documents
• Marketing material for last few years
• Interviews with the marketing manager or the person involved with marketing
• External and internal research data
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Legal due diligence
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For legal due diligence we need to make sure the company does not have legal problems and is being correctly operated. Legal due diligence requires the buyer to review all legal contracts and agreements made by the firm. Several legal artefacts must be reviewed including:
• Review all contracts. A company in business can have several contracts in place including contracts with suppliers, customers, employees and others.
• Agreements with employees
• Corporate charter and bylaws
• Non Disclosure Agreements (NDA) with employees
• Patents, copyrights and other assets in the company
• Minutes and consent from board of directors and shareholders
• Litigation related documentation and summary of current and pending disputes
• Review tax documentation from a legal stand point
• All artefacts related to the issuance of securities
There are several checklists available to guide you through the process of conducting legal due diligence.
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