Due Diligence Reviews

Due diligence is the fundamental analysis of your company's operations, financial position and results, legal standing and management experience and capability. Most generally, diligence is performed as a result of a pending corporate finance transaction, be it a capital placement or merger and acquisition activity. 

Who Performs the Due Diligence Review?

The person heading up the due diligence review is usually a member of the funding organization or senior member of the company making the acquisition. Often times, they are assisted in their efforts by outside advisors such as accountants, lawyers and investment bankers who know their way around the deal process as well as the books and records or even the operations. From time to time, especially with more technical or complex transactions, advisors such as engineers, industry experts, search executives or other specialists are retained to assist in the process. As a general rule of thumb, if there is one very important aspect of your business that requires more intense scrutiny, you can expect that a seasoned deal advisor will bring in a specialist to research that area.

What Documents Are They Looking At?

During a diligence review, you will be asked to provide a significant amount of detailed information concerning the workings of your company. Typically, financial statements, tax returns and all types of supporting records and supplemental schedules will be one of the first information requests. Legal agreements, articles of incorporation, by-laws, patent and trademark filings, option plans, 401(k) plans - any type of legal documentation that has to do with key assets or basic corporate standing will also be requested. You can expect any number of interviews, particularly of senior managers and owners, to take place. Finally, any extraordinary matters such as lawsuits, governmental inquiries, bankruptcy filings and so on will also be subjected to special scrutiny.

What Are They Looking For?

Primarily, diligence reviews are aimed at two different items: those things that support your statements about your company's condition and those things that negatively impact its value or increase the risk of entering into a transaction with your company. Accordingly, diligence reviews will focus on "checking off" supporting documentation about the positive aspects of your business on one hand, while on the other hand, they will be investigating any possibility of a "deal breaker" type of problem.

During the diligence process, you will want to be reasonably forthcoming throughout the process in order to establish a trust relationship with the other party. If you are hiding major problems, you can expect that (a) they will be found eventually and (b) some negative reaction will occur, ranging from the termination of negotiations to a possible legal action. Principally, by not being upfront about problems, you run the risk of damaging your company's and your own reputation or credibility in the marketplace and thus hindering future opportunities.

What About Privacy?

If you are concerned about sharing the details of your business during a diligence review, you should consider two things. First, professional firms and financial institutions handle sensitive information as a matter of course and they would be hindered, or even be subject to litigation, if it came out that they divulged your company's confidential information and thus breached a trust. Secondly, you can ask, but do not expect that a capital firm will sign a non-disclosure agreement (NDA).

Do Your Own Review

You have to expect that you will be sharing a great deal of private information - both business and personal - with outsiders if you wish to complete your targeted transaction. To find some comfort level, do your homework by finding out the background of the key partners or executives at the capital firm to see not only their experience level, but where they received their early training. Then communicate your desires as to how you would like your confidential infomration treated.

How Can You Prepare?

Preparing for a diligence review is not as difficult a task as it might first seem. There are standard information requests for which you can prepare a "diligence book" to be handed over in the early stages of the review. Items generally requested include the following: documents of corporate standing and formation, any loan and lease agreements, financial statements and key supporting schedules for inventory, accounts receivable, payable and non-current assets and liabilities and the corporate 'minute' books of Board and annual meetings. If your company has had prior equity fundings, a stock option plan or other such transactions and agreements, these, too, will be requested.

Preparing a diligence book does two things. First, it saves you time and needless distraction from your daily schedule. Secondly, it shows that your company has achieved a certain level of preparedness and sophistication in matters of corporate finance.

As your company grows, it is very likely that you will eventually be subjected to a due diligence review. Keep in mind what is at stake with the proposed transaction and prepare your company as best you can.