Before a mergers and acquisitions deal is finalized, the buyer should perform a “due diligence” appraisal of the business they plan on buying. Due diligence can help a buyer assess the value of the company and the risks involved to decide whether the business is a good fit for their portfolio.
Why Is Due Diligence Important Before an M&A?
Buying a company is a significant investment, so you want to make sure that a business is profitable and that you aren’t walking into a mess left by the previous owners. Before you ink the deal, due diligence investigates all aspects of a company, such as its assets, liabilities, obligations, litigation risks, intellectual property issues, employee matters, and contracts.
Besides providing you with information you can use to decide whether you want to move forward in a transaction, due diligence can also be beneficial for bank financing, preparing a financial audit, or taking a company public through an initial public offering (IPO).
Sellers can also benefit from a due diligence appraisal to show any weaknesses in their business that need to be improved to get the maximum price when they sell the company.
What Is a Due Diligence Checklist?
A due diligence checklist lays out all the questions you need to ask the seller before finalizing the transaction and receiving any information required. A checklist can help ensure you don’t overlook any important details about the business.
A due diligence checklist provides a road map of what a buyer should learn about the company they are buying, including its sales, liabilities, assets, benefits, and possible problems. Sellers may benefit from doing a reverse due diligence checklist to investigate their company’s weaknesses and strengths before considering selling.
Here are 10 topics to include on your due diligence checklist before buying a company.
1. Is the Target Company a Strategic Fit?
In deciding whether you should buy a business, you should consider whether the target company is a good strategic fit with your current business. Will you be able to retain the target company’s key employees? How much will it cost to integrate the target company into your existing business?
2. What Is the Corporate Structure and Organization of the Target Company?
A buyer should obtain several corporate documents for a target company they plan on acquiring. Some of the documents can include the following:
- Corporate bylaws
- Organizational charts
- Incorporation documents
- Stock option agreements
- A list of securities holders
- Stockholder and voting agreements
- Stock appreciation rights plans and related grants
- Warranties
- A list of subsidiaries and the jurisdictions they are qualified to do business in
- Tax authority certificates
- A list of current officers and directors
- Stockholder meeting minutes
- Board of director meeting minutes
- Rights of first refusal or first negotiations on the sale of the company
- Exclusivity obligations
- Agreements for the sale or purchase of the business
- Recapitalization or restructuring documents
3. What Is the Company’s Financial Standing?
Before you buy a company, you may want to have a corporate attorney go over the company’s financial statements, both current and past, and analyze the target company’s financial projections for the future. Your analysis should look at financial statements from the past five years and include information such as:
- Income statements
- Balance sheets
- Operating budget
- Projections
- Forecasts
- Cash flow
- Capital expenditures and other investments
- Earnings Before Interest, Taxes, Depreciation, and Amortization (EBITDA)
4. What Is the Target Company’s Tax Information?
You should also obtain the target company’s federal, state, local, and foreign tax returns for the last three to five years. Other important tax information to include are:
- Tax liens
- Audit reports
- IRS Form 5500 for 401(k) plans
- State sales tax returns
- Excise tax filings
- Employment tax filings
- Tax settlement documents
- A list of undisclosed tax liabilities
- Any correspondence with foreign, federal, state, or local taxing authorities
- Agreements waiving or extending the tax statute of limitations
- Tax sharing and transfer price agreements
5. What Insurance Policies Does the Target Company Carry?
You’ll want to know what insurance policies the company you plan on buying is currently carrying and when those are scheduled to renew. The seller can provide you with copies of insurance coverage, including any claims that have been filed within the past five years. Insurance policies may include:
- Worker’s compensation
- General liability
- Errors and omissions (E&O)
- Directors & officers liability (D&O)
- Product liability
- Keyman
- Intellectual property
- Employee liability
- Vehicle
- Health
6. What Are the Target Company’s Material Assets?
A seller should be able to provide you with a list of the target company’s material assets, their value, and any debts or liabilities against them. These assets can include:
- Real estate
- Inventory
- Equipment
- Technology
- Research and development
7. What Intellectual Property Does the Target Company Own?
Intellectual property is intangible, legally protected assets of a company. They can include:
- Copyrights
- Patents
- Trademarks
- Trade secrets
- Licenses and licensing agreements
- Branding and logos
- Domain names
- Technology
Before you finalize the purchase of a target company, you should get a summary of any claims on the intellectual property made or threatened against the business. The seller can also provide you with copies of licenses of intellectual property to and from the company and consulting and invention agreements.
8. What Contracts Does the Target Company Have in Place?
A critical yet time-consuming part of any due diligence analysis before an acquisition is obtaining and reviewing all the target company’s material contracts. These contracts can include the following:
- Guaranties, loans, and credit agreements
- Customer and vendor contracts
- Partnership or joint venture agreements
- Non-compete agreements
- License agreements
- Settlement agreements
- Franchising agreements
- Equipment leases
- Indemnification agreements
- Employment contracts
- Real estate leases
- Exclusivity agreements
- Union contracts and collective bargaining agreements
- Distribution, dealer, sales agency, or advertising agreements
- Powers of attorney
- Equity finance agreements
9. What Current or Past Litigation Has Been Filed Against the Target Company?
You’ll want to know the legal liabilities of a target company before an acquisition. The seller should provide you with information on any threatened, filed, pending, settled, or arbitration lawsuits.
10. Are There Any Antitrust or Regulatory Issues with Acquiring the Target Company?
Even if you’ve finished a thorough due diligence analysis of a target company, the government could prevent the acquisition from moving forward if you don’t consider the deal’s possible antitrust or regulatory issues.
Consult With an Attorney to Assist with Your M&A Due Diligence Checklist
This is just a synopsis of the topics you should include on a due diligence checklist when you are the buyer in a mergers and acquisition deal. To ensure that crucial steps don’t get missed, you should work with an attorney to create and complete a comprehensive due diligence checklist before the agreement is finalized.
At Confie, our M&A professionals have the necessary expertise in due diligence to navigate you through your acquisition. If you are considering selling your insurance agency, we’d love to talk with you, so contact us today.
