Due diligence is performed before mergers and acquisitions (M&As) for investigating and confirming all the facts related to the target company. 10 steps for performing due diligence are discussed in this post.
When you decide to purchase a company, whether through a stock transaction, asset transaction, or merger, it is essential to confirm all the facts related to the target company. Especially, facts pertaining to the finances and operations of the company should be thoroughly investigated to ensure that you are fully aware of what you are getting into.
A professional due diligence team is generally relied upon for this investigation. While the due diligence procedures can vary, here’s a quick overview of how it is performed in 10 simple steps-
1. Evaluating Project Goals
Like any other corporate project, the first step to perform due diligence is objective evaluation. Understanding why the due diligence is being performed can help pinpoint the resources required for the process, facts that should be investigated, and ensure alignment with overall business objectives.
2. Terms of Engagement
In the next step, the terms of due diligence are finalized between both parties. An NDA (Non-Disclosure Agreement) is signed between the parties outlining the objectives and requesting full cooperation from the target entity.
3. Financial Due Diligence
Accounting or financial due diligence focuses on the economic standing of the target company. The external due diligence team will look at historical projections, trends, tax risks, etc. to ensure there is a sense of consistency in the company’s assets, accounts, and liabilities.
4. Competitor and Industry Evaluation
Once the company’s financials are investigated, the next step is to analyze the industry in which it is involved and its competitors. This helps provide a decent overview of the company’s market potential. Margins of 2-3 competitors are evaluated for the same.
5. Legal Due Diligence
Due diligence professionals will also closely evaluate all the legal contracts and related documents to search for hidden lawsuits and risks. Contract copies of purchase agreements, leases, sales contracts, employee agreements, intellectual property, business registration documents, etc. are investigated.
6. Operational Due Diligence
How the target entity operates is the focus of this step. Factors like market, business model, and customers are investigated during operational due diligence. Identifying customer patterns, conducting market analysis, and analyzing business marketing are some of the measures taken in this step.
7. Human Capital Due Diligence
Investigating the staff and management of the company is also a critical aspect of due diligence. It is performed to investigate the employees’ qualifications and skills to identify skill gaps if any. Creating a list of all the employees, comparing their wages to industry standards, and over viewing the company’s benefit plans are some aspects of human capital due diligence.
8. Identifying Business Risks
Based on the information collected, the due diligence team would outline investment risks to help the acquirer or investor make the right decision. Internal risks specific to the company and industry-wide risks are focused upon in this step.
9. Future Expectations
The accountants and business advisors from the due diligence team dig further to try and find out the estimated revenue and profits of the target company in the next few years. Company partnerships, joint ventures, and long-term industry-related factors that can affect the company revenue are highlighted for the same.
10. Reporting of Information
A due diligence report is prepared and shared with the acquirer/buyer and/or seller. Based on the information included in the report, the buyer can raise further questions before finalizing the deal.
Risks of Not Performing Due Diligence
A buyer can avoid making an expensive investment or purchase mistake through due diligence. Professionals evaluate every critical aspect related to the target company to provide a clear picture to the buyer.
Always consider a reputed business consulting firm that excels in due diligence to access expert lawyers, accountants, and business advisors who thoroughly understand M&As and are well-versed with modern business dealings.