Due diligence is a term we all have heard about but most don’t know what it really means. Due diligence is generally defined as an investigation or audit of a potential investment such as buying a printing business. Due diligence serves to confirm all material facts in regards to a sale.
Due diligence is for a defined period of time usually immediately after an agreement is made to move forward on a business transaction. The agreement is usually a signed letter of intent or a term sheet which outlines the business transaction.
Here’s a list of what I recommend that you need to examine during the due diligence period – some of the items may not apply but many may be overlooked.
- The Company's organizational chart.
- The Company's list of shareholders and number of shares held by each.
- A list of all of the Company's assumed names and copies of registrations thereof.
B. Financial Information
- Financial statements for three years, together with Accountant's Reports.
- The most recent internal statements, with comparable statements to the prior year.
- Any projections, capital budgets and strategic plans.
- A schedule of all indebtedness and contingent liabilities.
- A schedule of inventory (not detailed).
- A description of depreciation and amortization methods.
- Any analysis of fixed and variable expenses.
- Any analysis of gross margins.
C. Physical Assets
- A schedule of fixed assets (verify what is actually there and working).
- All U.C.C. filings (only for equipment you will acquire).
- All leases of equipment.
D. Real Estate
- Copies of the real estate lease and any applicable zoning approvals, variances or use permits.
E. Intellectual Property
- A schedule of any patents, trademarks, copyrights or trade names.
F. Employees and Employee Benefits
- A list of employees including positions, current salaries, salaries and bonuses paid during last three years, and years of service.
- All employment, nondisclosure, nonsolicitation or noncompetition agreements between the Company and any of its employees.
- Background of key employees.
- The Company's personnel handbook and a schedule of all employee benefits and holiday, vacation, and sick leave policies.
- Summary plan descriptions of qualified and non-qualified retirement plans.
- A description of all employee problems for the last three years, including alleged wrongful termination, harassment, and discrimination.
- A list and description of benefits of all employee health and welfare insurance policies or self-funded arrangements.
- A description of worker's compensation claim history.
- A description of unemployment insurance claims history.
G. Licenses and Permits
- Copies of any governmental licenses, permits or consents.
- Any correspondence or documents relating to any proceedings of any regulatory agency.
H. Environmental Issues (only if you are taking over their space)
- A description of the Company's disposal methods.
- Copies of all correspondence, notices and files related to EPA, state, or local regulatory agencies.
- A list identifying and describing any environmental litigation or investigations.
- A list identifying and describing any contingent environmental liabilities or continuing indemnification obligations.
- Federal, state, local, and foreign income tax returns for the last three years.
- States sales tax returns for the last three years.
- Any audit and revenue agency reports.
- Any tax settlement documents for the last three years.
- Employment tax filings for three years.
- Any tax liens.
- A schedule of all subsidiary, partnership, or joint venture relationships and obligations, with copies of all related agreements.
- Copies of all contracts between the Company and any officers, directors, 5-percent shareholders or key employees.
- All loan agreements, bank financing arrangements, line of credit, or promissory notes to which the Company is a party.
- All security agreements, mortgages, indentures, collateral pledges, and similar agreements.
- Any installment sale agreements.
- Any distribution agreements, sales representative agreements, marketing agreements, and supply agreements.
K. Product or Service Lines
- A summary of any outstanding complaints or warranty claims.
L. Customer Information
- A schedule of the Company's largest customers in terms of sales and a description of sales for past two years.
- A description or copy of the Company's credit policy.
- A schedule of work-in-process.
- A list and explanation for any major customers lost over the last two years.
- The Company's current advertising programs, marketing plans and budgets, and printed marketing materials.
- A description of the Company's major competitors.
- A schedule of all pending litigation.
- A description of any threatened litigation.
- Copies of insurance policies possibly providing coverage as to pending or threatened litigation.
- A list of unsatisfied judgments.
N. Insurance Coverage
- A schedule and copies of the Company's general liability, personal and real property, product liability, errors and omissions.
- Key-man,directors and officers, worker's compensation, and other insurance.
- A schedule of the Company's insurance claims history for past three years.
- A schedule of all law firms, accounting firms and consulting firms engaged by the Company during past couple of years.
P. Articles, Publicity, and General Marketing
- Copies of all articles and press releases relating to the Company within the past three years.
- A copy of their website hosting agreement and domain name registration
Only after you have obtained and are satisfied with all of the relevant due diligence checklist items, should you start drawing up the purchase contracts. If you find any discrepancies or issues, you may want to renegotiate the terms of the sale or pass on the purchase.
Almost every deal that I see that the buyer says do not work out as well as expected was as a result of not properly conducting a complete due diligence on the seller. Do not rely on the word of the seller as it up to you to verify the claims and assumptions you have made to buy the business.
I also recommend that you have someone outside of your company help you through the due diligence period. Most buyers are excited about the deal and can’t wait to close the deal. A good professional will examine the due diligence documents carefully and give advice on anything that is questionable or could affect the buyer adversely after the closing.