While conducting due diligence, various factors are taken into account including obligations, liabilities, the company structure, as well as financial and legal matters. This process is often adapted to industry-specific requirements.
Due diligence is a vital process both for a seller and a buyer. While it may seem time-consuming, effort-intensive, and even confusing at first glance, the end result will be rewarding. Execute correctly and you'll have more clarity and confidence in your deal, a smoother integration process, and minimised chances of any risks, liabilities, or warranty claims.
How to perform due diligence on a company
When you perform due diligence on a business, a thorough investigation of company records and references is carried out to ensure everything is as it appears and there are no nasty surprises later down the line.
Typically, the buyer will lead the due diligence process, which begins with asking the seller to provide information about the target company and its operations. The buyer will then review this information.
To facilitate the process, the seller will set up a virtual data room to allow the bidders access to the information related to the deal. To make the due diligence more efficient and streamlined, the information in the data room is organised in folders following the structure outlined in the due diligence checklist.
The process is different in the case of an auction sale, in which the seller will manage the due diligence process.
The scope of the due diligence will vary depending on the transaction. The process is often lengthy and complex, requiring the purchaser, their internal team, and many advisers to review numerous documents.
A minor transaction may require only a few key factors to be considered during due diligence. There is a possibility that the buyer is familiar with the target company and its operations. It may also be possible where the business is simple and not highly valuable.
How to perform best practice for business due diligence
- No matter the size of the target company, resist the urge to do business due diligence on your own. Instead, involve an accountant and lawyer with business due diligence experience, as they can spot the red flags that might have been overlooked. Although you can certainly be involved and review documents, it's best to have the help of professionals. The experts know how to spot red flags that you might have missed
- Create a due diligence checklist with your accountant and lawyer to ensure you have covered every part of the process. You can create your checklist, or check with your team if there is a relevant, existing document you can use to save time
- Before starting business due diligence, you and the other business owner will sign a confidentiality agreement. By signing, you agree not to contact anyone about the company or its products and services without obtaining the owner's permission first. This way, the sale will not be publicly announced before it is officially finalised.
How to perform due diligence on large companies
The complexity of significant transactions is increasing. Whether you're doing a merger or acquisition, selling off a company's division, or forming an alliance, it can be challenging to determine the actual value of a deal.
A simple, fact-based due diligence solution is essential to stay ahead in mergers and acquisitions, especially in large-cap and middle-market organisations. To make sure your large-scale due diligence goes smoothly, take note of the following:
- Pay specific attention to the company's value proposition, market position, historical performance, and industry trends. This helps investors assess whether it will be profitable or meet forecasted revenue projections.
- Don't hesitate to compile a thorough private equity investment due diligence checklist. Having a detailed list reduces the likelihood of investors discovering inconsistencies in documents or operational processes once the deal has already been closed.
- Learning everything you can about the company's investments, transactions, and plans will be beneficial. For example, a private equity investment should look at anticipated transaction sizes, holding periods, industry focus, and investment stages to understand the fund's overall strategy and target size.
The private equity due diligence checklist may seem like a monumental task, but it will save you a great deal of time and headaches before an investment is made.
M&A (Mergers And Acquisitions) success rates are improving, but about half of all large deals fail to deliver the expected returns.
From Deal making: Using strategic due diligence to beat the odds
How to perform due diligence on startups
Venture capital firms use due diligence to analyse and evaluate startups to minimise uncertainties and risks. To avoid jeopardising a deal, startups' management teams must be transparent during due diligence. Companies that are honest about pending lawsuits, patent disputes, disgruntled employees, and business mistakes will move forward more quickly.
It is important to remember that investors will not rely only on the information you provide. In addition to internal and independent checks, they may conduct interviews with former or current employees and even reach out to customers to hear their input on your product.
The due diligence process can be exhausting and time-consuming, so founders must devote adequate time and resources to ensure a smooth due diligence process. A failed due diligence process can significantly devalue a startup, so here are some insights that can help with the process:
- Buyers can evaluate the entire product portfolio for potential technology and innovation opportunities. Most importantly, they need a clear view of how a digital acquisition brings sustainable value. Startup due diligence should get visibility to the research and development pipeline and steps to support product evolution
- Correctly assessing synergies and risks that do not relate to the core business may be difficult, especially if a company is not profitable yet
- Talent is the lifeblood of a startup, including founders, engineers, and technologists, whose talent is the key to its success. Make sure to identify the critical talent and consider how you should structure the retention early
How to perform due diligence on a private company
Now, let's look at what due diligence means for private companies. You should usually conduct a three-step investigation on a private company you intend to acquire or merge with.
An evaluation of financial statements, such as quarterly or annual reports, is the first step of the due diligence process. You cannot rely on stock data when performing due diligence on a private company like you might for a public company. Instead, you will need to analyse the business's performance in-depth. A company might publish general revenue information when it crosses a particular milestone, for example, a $100M annual recurring revenue, but you can also ask your targeted company for specifics.
Market research is the second step in performing due diligence on a private company. Engaging a target company requires thorough market mapping and familiarity with sector dynamics. This step aims to confirm that your previous research matches your target company's claims and beliefs. An alignment mismatch here could cause more severe problems.
During the next step in the private company due diligence, you may want to uncover insights into the health of the company's culture. Reviewing employment contracts and HR policies, including details on health and employee benefits and even employee turnover rates, should be considered part of this process. This will help you draft personnel retention strategies.
Due diligence on a private company begins with firms embracing the idea that risk goes hand in hand with investment. When performing private company due diligence, you can better understand the risks and opportunities.
How to perform due diligence on a small business
According to Deloitte, failure to correctly identify and manage third parties can cause revenue losses ranging from $2 to $50 million. Your company should take adequate measures to safeguard operations and avoid potential pitfalls when dealing with small businesses.
Here's a simple checklist to help you visualise how to perform due diligence on a small business:
- Assess your small business due diligence objectives
- Determine the small business type
- Understand small business' legal structure
- Investigate the financial health
- Examine the management team
- Review the website and social media accounts
- Identify possible signs of fraud
- Obtain expert opinions in small business due diligenc
To ensure the best outcome, consider the following risks when doing due diligence on small businesses:
- It would be best if you kept in mind that small businesses usually run on a tight budget and may be vulnerable to changes in supply and demand
- Ensure that compliance procedures are followed. The consequences of non-compliance can trickle down to your business in fines and penalties
- Due to their lower entry barriers, small businesses may be more susceptible to fraud, such as misrepresenting products or operating outside of accepted financial, legal, and ethical standards
Regarding due diligence for small businesses, it should be a relatively quick process. If it drags on, this may be a warning sign that there are issues you have not considered.
It may be easier to conduct due diligence on a small business, but it's important not to cut corners. You will be able to build solid and lasting relationships with your small business partners with a thorough, timely, and fact-based due diligence process.
Conclusion
Due diligence is essential for all deals, whether mergers and acquisitions, major investments, or forming partnerships with suppliers or customers. Performing due diligence on a company is a critical step before signing anything so that you can make a fully informed decision.
Your research should include information about the business structure, products, and physical and intellectual property. Set clear research objectives, keep the investigation focused, and leverage the latest technologies to your advantage.
Now that you've got comprehensive insight and tips on the due diligence processes of different business types, it’s your turn. To get comprehensive insights into due diligence and its best practices, download our guide:
