Due diligence is one of the most crucial parts of the purchase process for buyers. It is essential for buyers to take the due diligence stage seriously and turn over every stone. Otherwise, they risk being blindsided by problems the company has that were not disclosed by the seller. In this review, we discuss a range of important insights to know about buy-side due diligence.
Due Diligence is a Review and Audit of The Business You Are Buying
Due diligence is the stage in the buying process where you (the buyer) have the opportunity to review and audit the company you intend to purchase. This includes a review of the company’s financial documents (tax returns, profit and loss statements, cash flow statements, etc.). You may also learn more about their operational procedures, visit their facilities, and meet with the seller (and other key members of the company).
Due Diligence is About Ensuring a Fair Purchase Price
The ultimate goal of due diligence is to ensure you are receiving a fair deal for the company you are purchasing. You may have had limited access to financial and legal information when you made your offer. With due diligence, you can confirm that your offer is a good one and fair based on the company’s information.
Due Diligence Should Focus on The Qualitative Factors
One of the best ways to ensure you receive a fair price is to simply measure anything that can be measured. In other words, focus on the objective metrics for the company, such as the company’s profits, assets, real estate, and more.
Of course, there are many non-financial considerations that may also come into play, such as growth potential (see below), industry trends, and the quality of the workforce. However, focusing on the qualitative elements is a great framework to build around and ensure you are paying a fair price based on the value of other companies worth within the industry.
The Buyer Should Assess The Company’s Growth Potential
As discussed, the qualitative factors of the company (i.e. financial documents) are important for building a framework that allows you to justify (or not justify) the company’s valuation and your offer price. However, the due diligence stage should go a step further and evaluate the value of a company based on its growth potential. In doing so, you may need to request certain documents such as the seller’s projections, future strategy documents, plans for expansion, etc.
The company’s marketing efforts (or lack thereof) may also provide some insights into what can be done to grow the company. Also, you should conduct a thorough evaluation of the industry as well during the due diligence stage. This should tell you the industry trend and shed more light on the growth potential for the company.
Due Diligence Involves a Detailed Review of The Company’s Records
As mentioned, the due diligence process involves the request for the seller to provide documents that detail the company’s financial, legal, and operational information. The documents requested may vary, but they generally include the following:
- Financial documents such as federal tax returns, profit and loss (P&L) statements, and cash flow statements
- Legal documents such as business licenses, permits, patents, industrial designs, and copyrights
- Property documents such as real estate appraisals, lease information, and equipment and inventory lists
- Contract documents such as partnership and franchise agreements, vendor and supplier lists, and employee contracts
- Insurance and liability documents
A review of company documents takes up a large portion of the time during due diligence. It helps to organize beforehand the list of documents you will need and notify the seller ahead of time so that they can have the documents ready before due diligence officially begins.
Due Diligence Likely Involves Seeing The Facility In-Person
During offers and negotiations, a simple video tour of the company’s facilities may suffice. However, during due diligence, you should make an effort to visit the facility yourself and monitor the daily work processes. You should also prepare a list of questions to ask while you are on the tour of the facilities.
In some cases, depending on the specifics of the company, it may also be beneficial to schedule interviews with other co-owners, investors, shareholders, executives, and high-level employees. These efforts can help you prepare for what is to come once the sale closes.
You Should Have a Detailed and Written Plan for Due Diligence
The seller may provide a due diligence roadmap to follow to help ensure due diligence progresses quickly. Although you should take your time and be thorough with your review and audit of the company, an efficient due diligence process is usually what is best for both sides.
To help ensure efficiency during the due diligence stage, you, along with the seller, should agree to a detailed and written plan for due diligence that highlights all that must be accomplished and a deadline for each. This helps ensure the seller does not drag their feet when collecting essential documents that you need to review or when scheduling a time for you to come and see the worksite, offices, and facilities.
Due Diligence May Involve Extensive Time and Effort
The seller may implement a due diligence roadmap to help ensure the process moves along smoothly. You may also have an established closing date as well, which can make fitting all due diligence tasks in can become a challenge. It is important to keep in mind that, in most cases, due diligence is a time-consuming and exhaustive process. While it may involve a significant time and effort investment, this is essential to ensure you are comfortable proceeding with the purchase.
A Mergers and Acquisitions Team Helps Ensure Successful Due Diligence
Sigma Mergers and Acquisitions offers coaching and consulting services for buyers. Whether you need assistance throughout the buying process or have already had an offer accepted and need help with buy-side due diligence, we are here to help. Contact us today to get started.