Reduce risk with our due diligence checklist

Mergers and acquisitions can make organisations greater than the sum of their parts. However, they can also put companies at risk if they are exposed to undetected vulnerabilities. Corporate due diligence checks involve the thorough scrutiny of a business to expose potential liabilities to investors.

If you’re not sure which elements to evaluate, a business acquisition due diligence checklist is a smart place to start. This strategic roadmap helps to inform investment decisions by detailing the target company’s financial debts, regulatory risks, operational issues, criminal history of directors and much more.

Below, we explain what due diligence involves, why it matters and how to conduct this meticulous analysis. Read on to ensure you don’t miss any crucial insights when weighing up a potential merger or acquisition.

What is due diligence in mergers and acquisitions?

Due diligence in mergers and acquisitions is an evaluation process that a buyer must perform on a seller before progressing with the transaction. It involves a thorough examination of a target company’s financials, operations, legal matters, and compliance practices to ensure there are no hidden issues or liabilities.

After all, buyers must validate the seller’s claims, minimise risks, and gain a deep understanding of the business before finalising any deal.

Although it can be an arduous investigation, this vital step helps avoid costly bombshells after the transaction is completed and improves the likelihood of a successful merger or acquisition.

Keep reading to learn more about the importance of due diligence.

Why is due diligence important?

Legal due diligence investigations should be completed any time a business or its assets are sold or acquired. Here’s why:

Risk assessment

A successful business may be plagued by a range of problems or weaknesses that are not obvious from the outside – and which require a trained and dedicated investigator to identify.

For example, the target company may be facing unresolved legal problems, financial obligations, contentious contracts, security vulnerabilities or other industry-specific liabilities.

By conducting due diligence, you can be confident in your target company’s standing – or flag causes for concern that must be addressed.

Reputation management

Like a bad apple, a bad acquisition will affect the parent company that becomes exposed to the same problems.

A merger or acquisition that threatens to tarnish your company’s track record could lead to serious consequences, from a temporary downturn in sales to a complete shutdown. Implementing a robust due diligence process can help mitigate these risks.

Valuation support

As well as ensuring brand protection and security, due diligence can also be useful in valuing an acquisition by detailing the target company’s assets, liabilities, and potential earnings.

It also offers a means to measure the duration and expense of integration, plus expected revenue.

This information can serve as a basis for negotiation on the price and terms of the deal. From there, it’s up to you as the buyer to make an informed investment decision.

Given the above considerations, it’s important to follow a comprehensive due diligence checklist and customise each step to the target company’s unique circumstances.

What is a due diligence checklist?

A due diligence checklist is a systematic tool used to evaluate a target company’s assets, liabilities, contracts, benefits, and potential issues. It helps analyse the business’s strengths, weaknesses, risks, and opportunities before the buyer commits to a merger or acquisition.

This checklist serves as a detailed guide for conducting this in-depth analysis.

Importantly, it should not be seen merely as a routine step.

Rather, it is a critical strategy that can determine whether the endeavour will be a success or lead to significant financial losses for both the acquiring company and the target.

But what exactly must a thorough due diligence checklist include?

Let’s delve into the essential elements required, no matter your industry.

Here’s how to do a due diligence check.

Corporate due diligence checklist

 

1. Legal due diligence

Evaluate any regulatory or compliance challenges associated with the target company. After the transaction, the buyer will be responsible for all outstanding obligations, contingencies, and limitations. Therefore, any red flags related to legislation or compliance should shape the deal’s structure.

Make sure to check for:

Litigation

• Past, pending and active litigation brought against or by the company
• Any threatened litigation that may occur in the future
• Consent decrees, judgments, injunctions, settlements and other orders
• Settled or unresolved arbitration proceedings
• Applicable antitrust issues
• Attorney correspondence regarding company audits

Legal compliance

• Articles of incorporation and bylaws
• Certificates of good standing
• Documentation related to any changes to the company’s legal structure
• The company’s compliance policy and standards of conduct

Contracts and agreements

• All contracts with partners, employees, clients, customers, suppliers and other stakeholders
• Loan agreements and lines of credit
• Franchise or licensing agreements
• Any guarantees involving the company

Intellectual Property (IP) and trademarks

• IP agreements
• Descriptions of any licensing revenue and expenses
• Patents and applications
• Trademark registrations and applications
• Copyrights and applications
• Chain of title records
• Documentation of any proprietary trade secrets and IT systems
• IP protection and enforcement documents

Licences and permits

• Government licences, permits or consents
• Correspondence and material reports to government entities and agencies
• Any citations, notes or threatened governmental proceedings

 

2. Financial Due Diligence

Request a comprehensive report of all past, present and future financial statements and data where possible. You should assess all documents associated with the audit, accounts receivable, assets, liabilities, and any other financial matters.

That way, you can determine the seller’s current financial standing and whether profits are sustainable for a fair valuation.

For example, does the target company have the funds to continue operating throughout the merger or acquisition process?

Confirming its ability to fulfil financial duties and contribute to future growth is essential.

Therefore, key areas to examine include:

General financial documentation

• Copy of the general ledger
• Schedule of accounts receivable and accounts payable
• At least five years of audited financial statements and accompanying auditor’s reports
• Income statements
• Balance sheets
• Cash flow statements
• Financial forecasts
• Budget plan

Assets and revenue

• Value and nature of assets like real estate, equipment and stock
• All revenue streams
• Sales contracts
• Pricing strategies
• Schedule of deferred revenue

Liabilities and expenses

• Debt financing arrangements
• Equity financing documents
• Past and outstanding loans
• Contingent liabilities
• Related party transactions
• All insurance policies
• Any company expense reports

Taxation

• Income, employment and excise tax returns for the past five years
• Tax structure documentation
• Documentation relating to any tax liens or settlements
• Past tax audit reports
• Pending tax audits
• Upcoming tax obligations
• Tax contingencies and risks

 

3. Organisational due diligence

This important stage in any due diligence checklist examines the target company’s structure from a staffing standpoint. It also offers insights into who owns the business, which is essential to understand if considering a merger or acquisition.

Remember to review the:

• Organisational chart
• List of executives and board members
• Details of any shareholders (including the amount of shares and dates of issuance)
• Any records regarding the issuance or distribution of stock, options, and warrants
• Documentation relating to previous and current shareholder agreements, and other ownership-related issues, such as:
  • Voting agreements, trusts and proxies
  • Rights of first offer or refusal and preemptive rights
  • Transfer restriction agreements
  • Registration agreements

 

4. Operational due diligence

Operational due diligence involves a thorough examination of the target company’s systems and processes to detect potential risks related to business operations.

At this point, buyers should evaluate the target’s operating structure to spot strengths and shortcomings. The aim is to assess efficiency, identify any bottlenecks, and find opportunities for improvement.

Core considerations at this stage of the due diligence checklist include:

Business operations

• Description of the company’s operating model, including primary and secondary activities
• The products made or services delivered, staff employed and operational procedures at each site
• Documentation of all operational processes, including manufacturing summaries, service contracts and inventory reports
• Any agreements associated with research and development, quality control and customer service
• Information surrounding sales and marketing, such as industry research, CRM systems and lead-generation strategies
• General corporate records, such as meeting minutes and charter documents

Supply chain

• Manufacturers and suppliers
• Partners and vendors
• Distribution networks
• Inventory management procedures
• Supply chain risks

Wider strategy

• Strategic fit of the target company within the buyer’s organisation
• Key value drivers and performance indicators, from technology and products to team members and market reach
• Marginal costs associated with the merger or acquisition
• Details of the change management procedure

 

5. Commercial due diligence

Commercial due diligence assesses the target company’s position within the market by examining its competitors, consumers, industry trends, unique selling points and more.

That way, the buyer can form a deep understanding of the target company’s strengths and weaknesses. At the end of this process, stakeholders will have a clear view of the target’s market dynamics, revenue potential and growth prospects.

This section of your due diligence checklist should include:

• Portfolio of products and/or services
• Detailed market analysis covering size, share, conditions, trends, opportunities, threats, unique selling points, and future projections
• Existing and potential competitors, including their strengths, weaknesses, market share, and strategic positioning
• Strategies for market entry and growth
• Sales and marketing tactics, such as pricing strategies, distribution channels, and brand development
• Customer insights, including demographics, behavioural trends, acquisition costs, satisfaction levels, churn rates and lifetime value
• Customer retention tactics
• Long-term sales contracts
• Contracts with distributors
• Revenue model, including upsell or cross-sell opportunities

 

6. Asset due diligence

Every due diligence checklist should include an in-depth evaluation of all tangible assets. This includes verifying the existence, value, condition, ownership, and associated risks of the company’s real estate holdings, fixed assets, and inventory.

In turn, the buyer will gain a detailed insight into the target’s asset portfolio, and any responsibilities they’ll be taking on.

Ensure you assess the following:

• Mortgages, leases, and other legal documents related to assets, plus all associated information (e.g. repayments, terms etc.)
• Inventory records that cover item descriptions, SKUs, quantities, prices, locations and dates
• Valuations of real estate, equipment, machinery, inventory, and other tangible assets
• Records of major capital equipment sales and purchases over the past five years
• Physical inspections to evaluate the condition, upkeep, and status of buildings, facilities, equipment, and other physical assets
• Property taxes
• Records of any assets audits and surveys
• Utility and maintenance contracts

 

7. Human resources due diligence

HR due diligence focuses on the essential human element of a merger or acquisition. It involves a detailed review of the target company’s human resources policies, practices, culture, contracts and approaches to team management.

This analysis helps the buyer understand the potential effects of the deal on all employees, pinpoint any HR risks, and facilitate a smooth transition for staff.

To carry out this component of your due diligence checklist, you must review:

• Employee demographics
• All employment-related documents, including contracts, offer letters, non-compete clauses, and other relevant agreements
• Hiring and onboarding procedures
• Timelines and frameworks for performance evaluations
• Details on employee compensation and payroll records
• Employee benefits schemes, such as health insurance, retirement plans, stock options, purchase plans, and additional incentives
• Analysis of staff skills and strategies for talent retention
• Documentation of corporate values, mission, vision, and core beliefs
• Cultural compatibility between the acquiring and target companies, including values and management styles
• Interviews with internal and external stakeholders
• Evidence of compliance with health and safety regulations and their impact on employee well-being
• Records of any employment compliance issues, including labour laws, discrimination matters and workplace safety, and any active or past employment-related litigation
• Records of union relations

 

8. IT systems and cyber security due diligence

The Information Technology (IT) section of our due diligence checklist evaluates the target company’s IT infrastructure, systems and protocols. It analyses sustainability, scalability, value, costs, risks and compatibility with the buyer’s existing setup.

An IT system must be effective, adaptable, and secure. Therefore, the aim here is to uncover any IT-related threats, vulnerabilities, and compliance concerns that could jeopardise data security, operational continuity, or the success of the integration.

In tackling this stage, you should review:

• Inventory of software applications, databases, network setups, servers, and hardware utilised
• All outsourced IT contracts
• Documentation detailing IT procedures and management
• List of potential security weaknesses and hazards that cyber criminals may target
• Strategies to prevent hacking, breaches, and other cybersecurity incidents
• Disaster recovery and business continuity plans
• Data security and privacy protocols to ensure compliance with data protection laws
• Extent of employee training on IT security and best practices
• Compatibility of the target’s IT infrastructure with those of the acquiring company

 

9. Environmental due diligence

The increasing emphasis on sustainability highlights the need to thoroughly understand the environmental history as part of due diligence in mergers and acquisitions.

After all, environmental, health, and safety concerns may directly impact the valuation and reputation of the target company, not to mention those of the buyer.

Confirm whether the target company has been operating in an eco-friendly way by assessing:

• Interviews with past and present owners, operators and other stakeholders
• Records of infractions, complaints or information requests relating to the environment or workplace health and safety
• Details on any environmental and occupational health and safety initiatives
• Historical data sources, such as site photographs, fire insurance, and land use records
• Records relating to surrounding land
• Records from federal, state, local and tribal governments
• Permits and other documentation regarding environmental issues, including air quality, water use, and solid, liquid and
• hazardous waste storage and disposal
• Environmental cleanup records
• Documentation of hazardous substances and any past spills or releases

Tips for ticking off a due diligence checklist effectively

A tailored approach is necessary whether due diligence checks are for your firm or on behalf of a client. The difference between good and bad due diligence is that the latter treats every case the same and may not identify problems until after the deal has been signed.

Here are some tips for completing a corporate due diligence checklist successfully.

1. Take your time

Time is money but rushing the process could cost more if you don’t identify potential risks. Due diligence investigations generally take two to six months, depending on their complexity.

2. Look to the long-term

Mergers and acquisitions aren’t just about the immediate benefits. You also need to consider how an investment in another business will continue to yield returns in the future – whether that is saving money, allowing access to assets or intellectual property, opening up new geographic regions or other benefits.

3. Focus on more than just assets

Due diligence doesn’t end at finances, investments and debts. With cybercrime being a fast-growing threat, investigations are required to analyse a business’ data security and background checks on executives and employees to ensure your data will not be at risk.

4. Avoid bias

Don’t let enthusiasm for a deal blind you to possible flaws. If you are too close to being objective, hire an outside agency to complete your due diligence checks rather than using in-house lawyers.

Talk to the due diligence experts

Merging or acquiring a business is a substantial endeavour that demands robust due diligence. For a smooth and successful integration, you must identify and mitigate myriad risks across departments.

With the above mergers and acquisitions due diligence checklist, you can bring the truth to light so you know exactly what you’re signing up for.

However, as every business is different, there is no one-size-fits-all approach to these investigations. That’s why it can be prudent to hire specialists in due diligence to ensure nothing vital is overlooked that could place the business or its clients at risk.

At Bureaus FTC Report, we specialise in assisting large law firms with due diligence investigations to safeguard their own firms and clients.

To discover how our highly skilled local and global professional investigators can support your merger or acquisition with a due diligence report, download our free ebook: Law Firms and Investigations: How Bureaus FTC Report Can Help You Win Cases.