Due diligence process

You have just received the following email from Investor A:

“We have appointed some advisors to support us with performing due diligence on your company.

The scope of our due diligence is likely to cover the following topics:

• Financial due diligence
• Additional tax procedures
• Commercial due diligence
• Technology due diligence
• Legal due diligence
• Integrity due diligence
• Operations due diligence
• Human Resources due diligence

Please can you start brainstorming how we will collate the appropriate information into an online data room, such as the key documents that are likely to be requested by Investor A and their representatives.

We have included a list of requested schedules within Appendix 1.  Thanks”

Action required

Participants should perform the following:

1. Write down where you would source the relevant information from within your company to cover each of the items within Appendix 1.
2. Determine what technology software you would select to create your online data room.

Note that you do not need to actually produce any of the items for the purpose of this simulator.

Appendix 1: Due diligence scope

The scope of our due diligence procedures will be as follows:

Financial due diligence

• Review the historic income statement, Balance Sheet and Capex;
• Analyse cash flows and working capital cycles;
• Assess the reasonableness of future forecasts and key KPIs;
• Consider the quality of earnings reported versus the underlying sustainable profitability;
• Review the accounting policies;
• Assess management information levels and the internal control environment;
• Determine the financial impact of any commitments and contingent liabilities;
• Tax (see below for more details)

Additional tax procedures

• Review of recent tax returns including income tax, withholding taxes and sales taxes;
• Understand the level of compliance with all relevant taxes and review any tax correspondence, disputes or audits from relevant authorities.
• Assess the appropriateness of current tax liabilities, any unused tax credits or other potential tax opportunities arising from the acquisition.
• Determine compliance with international tax laws in each individual territory and for cross-border transactions.

Commercial due diligence

• Understand the level of concentration and mix of the customer base, the contractual commitments and satisfaction of key customers, and their future potential buying levels;
• Assess the effectiveness of the sales team, the quality of the sales pipeline and the likelihood of attracting or retaining customers post-acquisition;
• Determine seasonality, working capital requirements, customer renewal rates.
• Review the sales contract terms, future obligations and any open disputes.

Technology due diligence

• Understand the key elements of technology used within the business to determine its level of sophistication, effectiveness and future potential;
• Determine the level of ownership and protection of key technology solutions including any open source software, granted or received technology licenses, open disputes, liens and encumbrances;
• Identify any domestic and foreign patents, trademarks, copyrights and protection of IP.

Legal due diligence

• Review the Memorandum and Articles of Association, board meeting minutes, share certifications and all other significant company agreements;
• Review all material contracts and company commitments, and assess any potential impact of a change of control;
• Determine the ownership rights over the key business assets and real estate;
• Identify and consider the potential impact of any open disputes or litigation, and any non-compliance with relevant laws and regulations.

Integrity due diligence

• Review the identity of the company, its business background and activities;
• Check the business ownership and perform background checks on the key shareholders and management team;
• Check for political or official connections and search international sanctions lists and PEP databases.

Operations due diligence

• Understand operating costs, capacities and performance against industry peer groups;
• Identify the cost-benefit of any potential enhancements;
• Model the impact of different scenarios on the level of operating costs and capex requirements.

Human Resources due diligence

• Understand the organisational structure, key employees and their individual employment circumstances, including any non-compete arrangements.
• Determine employee packages, employment status, HR policies and any ongoing disputes.

END OF APPENDIX 1

GrowCFO Guidance Notes: Here is a quick overview of the due diligence process

Due diligence definition

Due diligence is an audit or investigation into the target business to better-understand the key items that may be relevant to any potential transaction and to seek more assurance over the accuracy of any information being presented by their management team.

This typically begins with some up-front analysis which is performed in-house, including:

• Understanding the products, technology, customer base and people;
• Meeting with key members of the management team;
• Assessing their strategic fit with the buyer, any potential synergies and the integration strategy;
• Scrutinising their management accounts; and
• Reviewing the business model and future forecasts.

As a deal process progresses and heads of terms have been agreed, acquirers often engage advisors to perform third party due diligence procedures prior to entering into any legally-binding agreement.

Types of due diligence

There are a range of different types of due diligence procedures available including the following list:

• Financial due diligence
• Additional tax procedures
• Commercial due diligence
• Technology due diligence
• Legal due diligence
• Integrity due diligence
• Operations due diligence
• Human Resources due diligence

When determining which due diligence procedures to carry out, management teams should consider the type of business being acquired and the reason for acquiring it.

When engaging specialist due diligence providers, management teams should decide whether to request a branded or non-branded report and whether to have a full detailed report or a summary “red flag” report which outlines the key issues to be brought to their attention.  These choices have a big impact on the overall cost of the report, in particular if the provider agrees to make the report available to any specified third parties.

Summary

There are many different types of potential due diligence projects available during an acquisition process.

Management teams should carefully consider which ones are appropriate to perform on an acquisition target and flex the scope according to the nature of the transaction.