The mind of an entrepreneur is wired to identify and take advantage of investment opportunities before others know they even exist. Sometimes this may require fully acquiring or partially buying into an existing company. Companies have to be profitable and have a capacity to scale up, to attract investors.
As with any business, there are also risks involved. To reduce the chances of losing money as an investor, you must conduct due diligence before entering into a contract. Due diligence is the process of evaluating a business in all aspects in order to determine if it is worth investing in. To get a clear picture of the company, you should delve deep into its financial data, mode of operations and future projections among other things.
It is however not easy for an individual to single-handedly conduct the due diligence for a large corporation. There are companies such as corporate resolutions that specialize in such matters. They have professional teams that allow them to provide a true picture of a company’s state of affairs. Corporate Resolutions has an entire private equity due diligence department that handles this extremely pivotal role: https://www.corporateresolutions.com/private-equity-due-diligence/
Areas of primary focus
Finance
Request for audited financial records of the company for the last five years. These include income statements, balance sheets, cash flow statements, and tax returns. The following should be considered when you or your accountant reviews them:
• Amount of bad debt written off each year.
• Are the accounts receivable being collected in a timely manner?
• Is the company paying its debts in a timely manner?
• What profit margins does the business have?
• Does the company have any outstanding liens?
Staff
This will ultimately be the team you will be working with. Ask for employee handbooks, organizational charts, retirement and benefit plans, non-compete agreements, confidentiality agreements and information on wages, salaries and commissions. Take note of the following as you go over them:
• Is there any unsettled grievance from a member of staff?
• Do any policies put the business at risk of lawsuits from employees?
• Are there any attempts to unionize employees?
Legal aspect
You should request copies of documents that show the legal obligations, benefits, and liabilities the business has. These are insurance policies, intellectual property documents such as patents and trademarks, licenses and permits as well as lawsuit related documents. Here are some details to pay attention to as you review them?
• Does company adequate insurance cover?
• Are the business’s licenses and permits up to date?
• Can the agreements be enforced?
• Is the company under any form of litigation and what implications could this have?
• Does the business own the rights to its intellectual property?
Structure of the business
Ensure you are given a copy of the corporate charter and bylaws together with the minutes of meetings held with the board members and shareholders. Consider the following :
• Will you need to change the structure of the business to actualize your scaling plans?
• Is the business in full compliance?
• What will the cost of buying out shareholders if need be?
Operations setup
Ask for a list of the operations manual, and lists of customers, suppliers, and vendors. Look for the following information:
• Are the inventory systems in place adequate?
• Is the business reliant on one major supplier or is the supply chain diversified?
• How broad is the client base and if it’s growing, at which rate?
• What equipment and infrastructure will be needed to continue growing the business?
Marketing and competition information
Go through the marketing strategy, growth opportunities, industry analysis, purchase agreements, and a SWOT analysis. This can help you determine the company’s market share and formulate measures to strengthen its position in the industry.
Why due diligence is important
1. You can estimate the value of the company on sale.
2. You gain an understanding of how the business is operated.
3. The obligations and liabilities you will take on become clear.
4. Information gathered can help you project the growth of the company.
5. It allows you to assess the entity’s relationship with stakeholders – suppliers, employees, customers, landlord, lenders, and creditors.
6. The weaknesses and strengths of the business are exposed.
Performing a due diligence exercise accords you a sneak peek of the business prior to committing your self. It also gives a clear indication of how trustworthy your future partners and employees are. It is the most important step in buying a company. It would be advisable to procure the services of a professional to get it right.
