Your due diligence checklist for business transactions

Whenever you’re looking to make a major investment in a business, such as a merger or acquisition, due diligence is essential.

It’s a comprehensive process of research that will ensure that you really know what you are getting into, and that everything is what it seems.

It will also give you a better understanding of the business and its future potential.

Here is a clear introduction to the due diligence process and a checklist of the key steps to follow in most circumstances.

What is due diligence?

Due diligence is a process undertaken by those either buying a business, buying into it or otherwise getting seriously involved with it. In other words, those most likely to perform due diligence are companies looking to carry out a merger or acquisition, major investors in a business, or a business looking to work with a major supplier or customer on which they will heavily depend. Before anything is signed, the due diligence must deliver a clean bill of health (or clean enough to satisfy you).

While carrying out the due diligence process, you should aim to find out everything you would need to know to make an informed decision when it comes to finalising the transaction. Ideally, you will research the company’s organisational structure, product lines, physical and intellectual property, and any existing business relationships and obligations it has.

By the time you start due diligence, you should already be aware of the ‘face value’ merits and drawbacks of the business in question, as regards an acquisition or investment. The job of due diligence is to ‘lift up the floorboards’ of the company in question and make sure there are no nasty surprises lurking underneath. If something is too good to be true, due diligence should find that out.

Who can help me with preparing due diligence?

Due diligence is a significant undertaking, so you’ll need help to compile your findings. You should collaborate not only with your organisation’s leadership team if you run a business, but also with representatives from the firm you’re researching, along with legal and financial professionals.

Every process is different, so you’ll need to identify your own points of contact for your particular scenario. If you’re involved in a merger or acquisition, there are specialist advisers who can help guide you through it. They’ll be able to provide their own detailed due diligence checklist, but read on to find out the sorts of things this may cover.

How long does the due diligence process take?

Due diligence can take anything from a few days to several months, depending on the size of the organisation being analysed. For a small business it should be a relatively quick process – if it drags on, this in itself may be a warning sign that there are problems you haven’t yet considered. In most cases, the process should be over in 60 days or less. Plan ahead, identify your research avenues and know where to stop.

What is the due diligence process?

Here are the key steps in a typical due diligence process:

1. Get an overview of the organisation

Before you’ve officially submitted an offer or come to an agreement, you should carry out an initial investigation into the business. Aim to get a broad understanding of its operations, objectives, opportunities and risks. Often, its leadership team will be reluctant to go to great lengths to provide detailed information before they can be sure you’ll invest in the organisation. So you may have to use publicly accessible resources to find your answers.

At this point, you should ask why your counterpart has decided to set up the transaction you’re exploring. For instance, are they selling their business because of falling profits? If they don’t provide a logical reason, be alert to potential warning signs during your analysis.

2. Complete an in-depth analysis

This stage will make up the bulk of your due diligence checklist. You’ll need to carry out site visits and review a large number of documents to boost your understanding across all areas of the business’s operations. You can help protect any files you request by using a virtual data room and only giving access to select individuals.

3. Evaluate the findings

As you gather your information, keep asking questions to help make sense of it. For example, do the projected revenues align with the current turnover? Are there any obvious risks facing the business? Throughout the process, be conscious of any gaps in your knowledge in case you need to switch your focus to pursue different lines of enquiry. 

4. Create a report and come to your final decision

When you’ve collected all the information you need, work with your peers to create a report. Taking this step will help you set out your findings in an organised way. Summarise any key data points, as well as the benefits and potential hazards of continuing with the transaction. Once you’ve completed this task, you should be in a much better position to decide whether you’d like to move forward, propose certain conditions, or walk away.

What should I have in my due diligence checklist?

The prospect of initiating a due diligence process can be overwhelming, but by carefully planning your approach, you can make your workload more manageable. The checklist below covers key areas for analysis in any business transaction. We recommend using it to create a broad research strategy and then adding to it wherever you feel you need to further focus your research. Depending on the business deal you’re pursuing, you may want to do extra investigations into product lines or compliance issues, for example.

Before you start looking at an organisation in detail, aim to conduct a thorough review of its industry, future trends and opportunities, and any competitors in operation. Armed with this knowledge, you’ll be better placed to evaluate the implications of your findings on the business.

Once you understand the industry, cover these six key elements in your due diligence checklist:

1. Operations

• Products and services
• Values and culture 

• Manufacturing, distribution and sales processes

• Product trials, warranties and complaints
• Contracts with business partners, shareholders, suppliers or other third parties

• Pricing, quotes, invoices and profit margins

• Age and efficiency of IT, software packages and other equipment
  

2. Financial information

• Annual reports
• Accounts and statements detailing cash flow

• Market share values, shareholders and their ownership percentages

• Expenses, debt, equity and any collateral
• Depreciation and amortisation processes

• Financial projections
  

3. Assets

• Fixed and variable assets
• Physical assets, including real estate and equipment

• Intellectual property, including trademarks, patents and trade secrets
  

4. Compliance and legal issues

• Insurance policies and previous claims
• All tax returns

• Litigation issues

• Licences and permits
• Environmental issues, including the use of hazardous products, disposal methods and any previous investigations
  

5. Employees

• Corporate structure and organisational charts
• Partners, consultants or freelancers, including finance and legal professionals

• Professional experience of senior board members

• Current employees, job roles and salaries
• Employee handbook and leave policies

• Onboarding and offboarding processes

• Employee benefits, including stock investment opportunities

• Pension plan policies and other benefits

• Employee complaints, disputes and compensation claims
  

6. Marketing

• Advertising campaigns and their effectiveness
• Published articles and press releases

• Marketing budgets

When researching aspects like accounts, insurance claims and employee complaints, aim to thoroughly review any documents filed in the past three years. Taking this step will help you avoid any nasty surprises further down the road. Once completed, the due diligence checklist should give you a comprehensive understanding of where the business has been and where it stands now, allowing you to move forward with confidence.

If you found this article helpful, you might also find our article on cybersecurity for small businesses informative, too.

Find an accountant to help you through the due diligence process.