This guide outlines a 10-step due diligence checklist that you should follow when merging with, or acquiring, another business.
Caveat emptor – buyer beware – is as sound a rule for corporate mergers and acquisitions as it is for consumer transactions. But acquiring and organising all the information necessary to weigh the pros and cons of a potential transaction can be a daunting task.
Most corporate merger and acquisition lawyers start with an exhaustive due diligence checklist that can be adapted for a particular transaction. These typically run to hundreds of items. But that’s your lawyer’s job, not yours. Busy corporate executives may find it more useful to think about due diligence as falling into 10 crucial areas of activity outlined in the due diligence checklist below.
10 steps for a due diligence checklist
Basic company information
Step one in the due diligence checklist is to collect the most basic information about the target company, including certificates of incorporation, bylaws, a list of officers and directors and minutes of board and committee meetings since inception. A buyer should also obtain copies of stock option and stock sale agreements and documentation of any other financial obligation that might be triggered by a change in ownership.
Financials
This generally includes an analysis of audited financial statements, monthly or quarterly historical financial information, audit work papers, and analysis of the details supporting publicly available financial information. Careful due diligence would also include interviews with financial management and the external auditors. This can yield useful insight into the need for future working capital and debt exposure.
Tax information
A company contemplating an acquisition or merger should certainly add to their due diligence checklist finding out about tax audits and any settlement agreements as well as any tax liabilities, whether historical or current, even if those will not become the responsibility of a new owner.
Legal
Legal matters are a crucial investigation on the due diligence checklist. Is the company being sued or is it suing anyone? Are there matters in arbitration? What about settlements? Does any of this litigation, past or pending, suggest management practices that may continue to be troublesome in the future?
Real and intangible assets
The financial statements should give good information about the value of tangible assets, such as equipment, buildings and leases. It is also important for the due diligence checklist that you evaluate the importance of less tangible assets like intellectual property, business reputation, customer base and even corporate culture and management, especially if a buyer is hoping to keep an existing management team in place.
Information technology
Outdated or insecure information technology can be a huge drag on a business’s potential for growth. If the systems are to be integrated, old technology may also expose an existing system to unanticipated risks. Open source software may be particularly problematic.
Material contracts
One of the most important aspects of a due diligence checklist and inquiry is a review of material contracts. These include agreements involving payments over a specified amount, equipment leases, loans, credit agreements, customer and supplier contracts and insurance contracts. In addition, counsel should review any franchise or dealership agreements, noncompetition agreements and powers of attorney, to list just a few.
Business plans
Does the target have a well-developed business plan, and is it generally in alignment with growth plan of the acquiring company? What are the opportunities for cost savings and other synergies after the merger or acquisition? The lack of a defined business plan or a plan that indicates a different direction may be a due diligence checklist red flag about the likelihood of a successful integration.
Marketing materials
A buyer should understand the target’s marketing strategies and arrangements. It is therefore important for the due diligence checklist success that you review standard company sales forms or literature, surveys of markets the company served or planned to serve, sales representative, distributor and agency agreements, as well as any other agreements relating to the marketing of the company’s products. These may provide additional insight into the competitive landscape in which the target business has been operating.
Employment
A buyer should review the target’s management organisational chart and compensation paid to officers, directors and key employees, including bonuses, incentive plans and non-cash compensation. What incentive arrangements are in place to retain key employees? Beyond the management structure, a buyer should also have the opportunity to review all employment manuals and policies. Has there been recent litigation with respect to the terms and conditions of employment? What layoff and severance costs are likely to be triggered by the merger or acquisition?
Final words
Proper attention to a due diligence checklist that explores these ten facets of a target company is essential to the success of your transaction.
Rolf Howard is Managing Partner of Owen Hodge Lawyers. He has been in the legal practice since 1986 and a partner of Owen Hodge Lawyers since 1992. Rolf focuses on assisting clients to proactively manage legal responsibilities and opportunities to achieve competitive advantage. Rolf concentrates on business planning and formation, directors’ duties, corporate governance, fund raising and business succession. His major interest is to assist business owners and their financial advisers plan and implement strategies to build and exit from successful businesses.
Photo by Wallace Chuck
