Whether you decide to purchase a business outright or expand your existing business by acquiring, or merging with, another business, there are many details that you need to consider to make your decision. Do not rely on the prospective seller to volunteer all the information that you will need in order to make the best decision.
Every seller will attempt to cast its business in the most favorable light. But the devil, as they say, is in the details. Businesses, even small ones, can be complex. Creating a well thought out due diligence checklist is the first step in developing a comprehensive understanding of the business under consideration. A due diligence checklist is, however, only the first part of an evolving due diligence process.
As items on your due diligence checklist are investigated, some items may be resolved; others may not. The further investigation of those unresolved items may lead to further questions that will need to be included on a supplemental due diligence checklist.
The ultimate goal of the due diligence process is for you to have in hand everything that you will need to make an informed purchase decision and to create the terms upon which you will be willing to purchase. The completed due diligence process should enable you to do a complete risk analysis of the target business.
What details should you investigate?
You should examine many different categories of items when investigating a business. There is no one size fits all. Here are a few of those categories:
- Documents about the company and its structure – From the company’s organizational documents and corporate organization chart to updated minutes from the meetings of its governing body, understanding a company’s structure and internal governance level proceedings can give you a high-level understanding of its operations.
- The Company’s Assets – Assets that a company holds like real estate, manufacturing equipment and intellectual property including domain names, form the core of the company’s economic value, regardless of whether the ultimate transaction consists of a purchase of the company’s equity or the sale of all or substantially all of its assets. You should also examine those assets closely. The condition of real property (whether owned or leased), the age and condition of manufacturing equipment, and the expiration dates of intellectual property protections can limit the value these assets offer. Real property leases need to be examined to determine whether a sale of the company triggers the need to obtain the consent of any individual landlord.
- Financial information – One of the most appealing aspects of a company may be its profit potential, and financial information can give you a clear picture of that profitability. However, it is important to get updated information to ensure that you understand the company’s current finances. Footnotes to financial statements can raise significant questions the need to be answered as part of your due diligence investigation.
- Contracts – What contracts are there with customers, vendors and suppliers? Which contracts are material to the value of the company and its continued operations? Do any of those contracts need to be assigned and, if so, does consent of the contract counterparties to the assignment need to be obtained? Does the business depend on a supply chain? What steps have been taken to assure that the supply chain remains uninterrupted both before and after the company is acquired?
- Employee information – What does the company’s workforce look like? What benefits has the company promised employees? Did the company recently lose employees in key positions? Are some or all of the company’s employees unionized? Do any of the employees have employment contracts that contain severance benefits if those contracts are terminated? A company’s employees are an important asset, and you should consider them when evaluating a company.
- Licenses and permits – Is the company’s licensure up to date? Which licenses are integral to the continued operation of the business? Are any licenses so integral that the form of the purchase transaction needs to be structured as a sale of the company’s equity rather than as a sale of its assets? In the case of a sale of the company’s assets, what steps need to be taken to acquire replacement licenses and what is the timing to obtain those licenses? In the case of a sale of the company’s equity, is any licensing authority entitled to approve a change of control? Does the company have the permits and authorizations needed in order to do business wherever it operates? When will critical licenses expire and what is the renewal process?
- Insurance – Insurance is a key element of every business. You will need to review with your insurance consultant the proper forms of coverage and amounts, exclusions and deductibles. Cyber insurance is extremely important, especially for customer facing businesses.
- Litigation – You need to know whether any litigation is pending or threatened against the company and to evaluate whether any litigation, or threat of litigation, is a risk that you are unwilling to accept.
- Security – Especially for businesses that handle sensitive information or have intellectual property assets that need to be protected, you should examine the security used to protect that information and those assets. As All Business notes, this should include reviewing any privacy and cybersecurity risks that the business may face based on the business’s market.
Performing due diligence is an essential way for you to ensure that the business you purchase is the business you thought you were purchasing when you first engaged with the seller.
It is important to work with an experienced attorney to guide you through the evolving process of your due diligence investigation and through the negotiation and closing of a purchase contract that reflects a transaction that is acceptable to you and that successfully reflects your goals.