Due diligence is the process of evaluating a business situation from all aspects before making a decision. Due diligence is often performed when buying a business, but there are many other situations in which due diligence might be performed.
Due diligence is not a general investigation but it includes specific elements which may vary based on the situation. Due diligence is performed to protect both parties, but primarily the purchaser, in uncovering potential liabilities and financial matters, to make sure nothing is hidden.
What Does the Due Diligence Process Involve?
The process involves both the principal (buyer or investor) and an accountant and attorney. During due diligence, you should:
1. Examine all records and documents, as described below
2. Spend time at the business location, talking to managers, executives, employees.
3. Check sales against customer lists to verify that the business has the customers it says it does
4. Look at potential future plans for expansion, condition of facilities, equipment, furniture, and fixtures to verify that they are as reported
5. Look at all documents which might incur liability for the company, including sales agreements, purchase agreements, liens on assets
6. With the assistance of your attorney, examine documents relating to any ongoing or potential lawsuits, and recent litigation that has concluded.
What Subjects are Included in the Due Diligence Process?
Although the subjects involved in the due diligence may change based on the situation, most of the time the due diligence process includes the following:
(1) General company information. A history of the company, its original and any succeeding business plans, the company's mission statement and short-term and long-term goals and objectives would be necessary here.
(2) Company management and employees. Who is in charge of the company? What are their credentials? What experience do they have? Are they honest and trustworthy?
(3) Products and services. If the company sells products, a catalog or listing of products is needed, along with information about competitiveness of these products. Brochures and price listings for products and services also must be reviewed. Pricing strategies, service availability, and terms of service are needed, Documents relating to company patents, copyrights, and trademarks must be provided, as well as licenses owned by the company and agreements with licensees.
(4) Operations. The due diligence process includes review of fixed assets, facilities, and equipment, product quality assurance and safety, suppliers and contracts. Inventory is often taken and inventory costing (LIFO and FIFO) is considered.
(5) Financial matters. Most important to the due diligence process are financial records. Records reviewed include balance sheets and income statements for past years, projected financial statements, insurance coverage, tax filings, and sources and uses of funds statements.
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