Module 9-: Due diligence is the careful analysis of a business by an entrepreneur looking to invest in that business. It’s a very important step towards making the right decision whether to buy a new business or not.
While most entrepreneurs understand the importance of due diligence in any business acquisition process, only few understand what they need to look out for in their purchase candidate before deciding whether it’s a good buy or not.
If you are looking to buy a business or plan to do that sometimes in the future, you need a detailed due diligence checklist template to guide you through the investigation. This will help you ensure that you didn’t miss out anything important. Here’s a due diligence checklist template that you can use when buying a business.
Due Diligence Checklist Template for Buying a Business
1. Financial information-: When analyzing a purchase candidate, start by checking the company’s financial information, under the following subheadings:
Financial information for the past three to seven years
Review the company’s annual and quarterly financial information for the past three to seven years–the longer into the past, the better. This will help you figure out how the business has been faring with respect to finances.
- Check the income statements, balanced sheets, cash flows, and footnotes.
- Review the planned versus actual results as well as management of financial reports.
- Review the breakdown of sales and gross profits by product type, channel, and geography.
- If there is a current backlog by customer, review that, too.
- And review the accounts receivable aging schedule.
You also need to look into the company’s annual and quarterly financial projections for the next three fiscal years.
- Review the projected revenue by product type, channel, and customers.
- Check the projected income statements, balance sheets, and cash.
- Look into the company’s major growth drivers to see if they would be effective enough to help realize the company’s projections.
- Review the predictability of the business. The more predictable it is, the more realistic the financial projections will be.
- Request and explanation of projected capital expenditure, depreciation, and working capital arrangements, so you will understand how the projections were come by.
- Ask if there are any plans for external financing.
- Check the industry and pricing policies to see if projected sales and profit figures are realistic.
- Check if risk factors such as exchange rate fluctuation and government instability have been factored in as well as challenges posed by unforeseeable economic factors.
You need to know where the company has sourced its capital from. In the case of sole proprietorships and partnerships, there’s not much work to do here. But in the case of corporations and public liability companies, you will need to do the following:
- Review the list of all stockholders with shareholding, options, warrants, or notes.
- Review all outstanding current shares.
- Review the summary of all debt instruments or bank lines with key terms and conditions.
- Review off balance sheet liabilities.
Other financial information
In addition to the financial information highlighted above, you will also need to review the summary of current federal, state, and foreign tax positions (including net operating loss carry-forwards), discuss the company’s general accounting policies (revenue recognition, etc), and review the schedule of financial history for equity, warrants, and debt.
2. Products or services-: After reviewing the company’s financial information, you need to analyze the products or services offered in terms of target customers and applications, historical and projected growth rates, market share, cost structure and profitability, timing of new products and product enhancements, and speed and nature of technological changes.
3. Customer and supplier information-: Since customers and suppliers are the lifeblood of any business, it’s more than necessary to make certain investigations about them when considering buying a company. During the due diligence process, request for the following:
- List of top 15 customers for the past two or three years (with full contact and purchase details of each) and current year-to-date by application
- List of strategic relationships
- Details of revenue by each major customer
- Descriptions of any significant relationships discontinued within the last two to three years
- List of top 10 suppliers for the past two to three fiscal years (with full contact and supply details of each)
4. Competition-: Because the success of a business in any sector hinges largely on the competition within that sector, you need to analyze the company’s competition. Figure out the company’s market position and related strengths and weaknesses in the market place. Also, analyze the basis of the competition—price, technology, service, distribution, etc.
5. Marketing, sales and distribution-: Start by reviewing the company’s marketing programs and strategies as well as marketing opportunities and risks. Then look into the positioning of the company and its products as well as its domestic and international distribution channels.
In addition, analyze major customers in terms of status and trends of relationships as well as prospects for future growth and development; principal avenues for generating new business; ability to implement marketing plan with current and projected budgets; and sales force productivity model in terms of compensation, quota average, sales cycle, and plan for new hires.
6. Research and development-: Review the description of the company’s research and development organization in terms of strategy, key personnel, and major activities. And analyze new product pipeline based on status and timing, cost of development, required technology, and risks.
7. Management and personnel-: Review the organizational chart as well as the historical and projected headcount by function and location. Check the summary biographies of senior management as well as their employment history, age, service with the company, and years in current position. Review compensation arrangement and personnel turnover. And review any significant employee relations problems, past or present.
8. Legal and related matters-: Check if there are pending lawsuits against the company or any initiated by the company. See a description of environmental and employee safety issues and liabilities. Request a list of material patents, copyrights, licenses, and trademarks. And check any other legal document available.