One of the most important steps in any acquisition is due diligence, which starts with your due diligence request list. This data gathering process helps provide assurance that there are no skeletons in the closet that could come back to bite you later on. According to The Institute for Mergers, Acquisitions and Alliances, “not anticipating foreseeable events” drives 39% of M&A failures. Let’s do all we can to prevent your acquisition from being in that category.
In this article, we’ll cover a 79 point document request checklist to help you evaluate a potential acquisition target. I’ll also walk through some potential red flags to keep an eye out for.
Due Diligence Request List: Checklist for Buying a Business
Each deal will be different, and you’ll need to tailor your due diligence request list to the specific transaction. With that said, there are certain key themes that should be on every list.
Due diligence can be a long and complex process, but it’s critical to be thorough and patient. A detailed review will help mitigate the risk of any surprises later on and give you a better understanding of what you’re getting yourself into.
As PwC says, now more than ever there is a “greater need to perform robust due diligence – both deeper and beyond traditional areas.”
This checklist will help you make sure that you’re asking all the right questions and getting the information you need to make an informed decision about whether or not to move forward in the process.
As always, consult with your professional M&A advisors (accountants, lawyers, etc.) to ensure that you’re covering all of your bases.
Corporate Due Diligence Documents
1. Organizational Chart
2. Employee Position Descriptions & offer letters (including compensation)
3. A list of all officers, directors and stockholders of the Company (including shareholders and percentages owned)
4. Formation documents and articles of incorporation
5. Company bylaws and amendments
6. State of incorporation status reports for the last three years
7. Annual reports for the last three years
8. Detailed documentation for any locations where the company has employees, owns/leases assets, and conducts business
9. Voting trusts, subscriptions, calls, puts, options, and convertible securities agreements
10. Certificate of Good Standing from each Secretary of State where company conducts business
Sales and Marketing Due Diligence Documents
11. Detailed overview of company growth strategy (what’s working and largest areas of opportunity)
12. Review of key growth drivers and projections
13. Clarity around value proposition, market segments, and areas of differentiation
14. Client Acquisition Strategy: how does the company consistently and reliably obtain new customers?
15. Any agency, promotion, PR or advertising agreements
16. Current customer list with historical customer detail (including revenue by customer and churn rate)
17. Review of service and product line pricing structures (helps you assess profitability by product line)
18. Review of salesforce including productivity, performance, tenure, and turnover
19. List of the ten largest customers and suppliers
20. Sales reports by category of product or service
21. Credit terms with customers (if applicable)
22. Current market share (if possible)
23. Key Performance Indicators: i.e. CAC, CLV, Marketing ROI (by channel)
24. Percentage of sales by each acquisition channel (e.g. inbound, Facebook ads, etc.)
25. List of major competitors for each business segment or product line
26. Competitive Landscape: details around market size and industry demand
HR Due Diligence Documents
27. Full list of current employees and independent contractors
28. Clarity around any existing or past labor union arrangement
29. Employee conduct handbook and safety policies
30. Policy documentation: bonus and incentive structure
31. Policy documentation: sick days, paid holidays, paid vacations and overtime pay
32. Copies of all OSHA examinations, reports or complaints
33. Detailed history: workers compensation, unemployment claims, and employee disputes
34. Detailed employee and independent contractor terms of employment
35. Detail updated employee resumes
36. Past results of any formal employee surveys and internal NPS scores
37. Outline training conducted with existing employees
Intellectual Property (IP) Due Diligence Documents
38. Patents: existing patents and applications
39. Existing copyrights, licenses, trade secrets and trademarks
40. Detailed history: IP claims and litigation
41. Liens on intellectual property
42. Licensing agreements
43. Ownership and rights of use detail for advertising copy, registered domain names, logos, and slogans
Financial Due Diligence Documents
44. At least 3+ years of audited financials (pay attention to trends and any anomalies)
45. At least 3+ years of tax returns
46. List of all bank accounts and balances
47. Balance Sheet (Monthly Breakdown)
48. Income Statement (Monthly Breakdown)
49. Cash Flow Statement (Monthly Breakdown)
50. Profit and Loss by Month Report
51. Financial projections and capital budgets
52. Gross margins analysis
53. Fixed/variable expenses analysis
54. Review of working capital trends/requirements as business scales
55. Details on when contracts and leases are renewed (will terms stay consistent or change?)
56. Review of capital investment requirements
57. Information on all reserves and unusual charges over the past five years
58. Customary accounting, insurance, legal, and tax diligence
59. Review of all material contracts, loan and credit agreements
60. Details of all company investments (stocks, bonds, etc.)
61. Schedule and copies of all insurance policies covering property, liabilities and operations.
62. List of all state, local and foreign jurisdictions in which the Company pays taxes or collects sales taxes from its retail customers
Contract Due Diligence Documents
63. Employee contacts (including any non-competes)
64. Active customer, client and supplier contracts
65. Joint venture and partnership agreements
66. Loans, credits, and guaranties agreements
67. Settlement agreements
68. Accounts Receivable
69. Accounts Payable
70. Property and equipment leases
71. Copies of all insurance and indemnity policies and coverages
72. Guarantees or similar commitments by or on behalf of the Company
72. Contracts relating to any completed (over the past 10 years) or proposed acquisition, merger, or purchase or sale of substantial assets
73. Samples of all forms (including purchase orders, invoices, and supply agreements)
Legal Due Diligence Documents
74. Detail around any past or existing litigation
75. Tax registration documentation
76. Shareholder certificate information
77. Business licenses at the local, state, and federal level
78. Occupational license, building, zoning and land use permits
79. Power of attorney documents
Watch Items and Potential Red Flags
As you work through your review, below are some potential red flags to look out for.
These are not an exhaustive list (and not necessary deal killers), but will give you a sense of some key items that might warrant some additional investigation.
I recommend leaning on the guidance of your advisors, but taking an active role will give you an extra level of confidence as you move forward in the deal process.
Human Resources Red Flags
- Excessive employee turnover in the past 12-24 months
- Key person dependency risks (is the owner or management team critical to day to day operations?)
- Management team retention risks (will they leave after the acquisition?)
- Pending litigation against the company by employees, former employees, or regulatory agencies
Intellectual Property Red Flags
- Inadequate protection of intellectual property rights, including patents, trademarks, and copyrights
- Pending or threatened litigation related to intellectual property rights
- Questionable ownership of intellectual property developed by employees, contractors, or consultants
Financial Red Flags
- Inconsistent or nonexistent financial controls and accounting practices
- Lack of a formal budgeting process
- Inconsistent or missing financials
- Significant deviations from budgeted expenses on a regular basis
- Unreported income or expenses (or unusual transactions with related parties)
Contractual Red Flags
- Expiration of key contracts within the next 12 months without renewal options
- Dependence on key suppliers with no viable alternatives
- Restrictive covenants (non-compete, non-solicitation, etc.) in key employee contracts
- Pending litigation related to contracts
Regulatory Red Flags
- Failure to comply with governmental regulations, including environmental regulations
- Pending or threatened litigation related to regulatory compliance issues
- Fines or penalties assessed by regulatory agencies
Operational Red Flags
- Obsolescence of key equipment or technology
- Outdated or unsupported software applications
- Inadequate capacity to support projected growth
- Lack of formalized processes and procedures
- Significant customer churn rate (low customer satisfaction and retention risk)
- Customer concentration risk with top 5 customers comprising more than 50% of revenue
- Inadequate security measures to protect data (including personal data)
Marketing and Competitive Red Flags
- Lack of a sustainable competitive advantage
- Imitatable product or service offerings (lack of differentiation)
- Revenue and/or profitability trending downward
- Limited detail around key KPIs (customer acquisition cost etc.)
- Key personnel poached by competitors
- Significant new competition in the market
- Erosion of pricing power
- Slow to adapt to changing technology or customer needs
Legal Red Flags
- Pending or threatened litigation against the company, its officers, directors, or key shareholders
- Arbitration or mediation proceedings pending or threatened against the company
Real Estate and Facilities Red Flags
- Expiration of lease within the next 12 months without renewal options
- Substantial leasehold improvements required to maintain current facility
- Ownership of real property encumbered by mortgages or other liens
Conclusion
As you can see, there are a lot of potential risks to consider when acquiring a company. This is why due diligence is so important. By taking the time to review all of the key areas of the business, you can avoid some major pitfalls down the road.
By asking these key questions and thoroughly investigating each answer, you can be confident that you’re making a smart decision for your business’s future.
What questions would you add to this due diligence checklist? Let me know in the comments below.
