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    What is Due Diligence ?


    Diligence is often performed by the potential buyer or investor on the business of the potential seller. Due Diligence could be considered an exhaustive review of all business documents and records in an effort to assess the health and viability of the business in question.

     

    Due Diligence is permitted by the seller once one or more prospective buyers or investors have been identified. The identification of potential buyers is a roll that can be greatly enhanced by employing an Investment Banker that believes in your business. Due Diligence is often only permitted once the prospective buyers have signed a NDA (Non Disclosure Agreement). The due diligence data room often contains copies of the most confidential data a company possesses.

    The process of creating a Due Diligence Data Room will primarily under the direction of your Legal Council. The lawyer you select to assist in transaction will provide an exhaustive list of all the documents which should be in the due diligence data room (here is an example Due Diligence Checklist). The documents in the Due Diligence data room are often arranged by topic. Below is an overview of each Due Diligence data room category.

    Financial Due Diligence

    The finance area is the most common section of the due diligence data room. This section contains not only the last two to three years historical financial records but also financial forecasts for the current year. Many companies would also include a 2-3 year financial forecast in the data room. Be careful not to forecast sales that are not realistic as terms of the sale may be tied to the successful achievement of the sellers forecasted revenue projections. These are called “earn outs”.

    The due diligence check list contained on this web site is a good starting point for compiling the financial records that will be required for review by the prospective buyer/investor. The financial due diligence data contained in the due diligence data room is critical in the determination as to the value of the ongoing business. Any and all “other income” should be documented.


    Legal Due Diligence

    The Legal Due Diligence section of the data room is frequently the largest section. It contains all the business legal documents as well as copies of all annual meeting minutes. The Legal Due Diligence should also contain a detailed explanation on ownership and owners of the company. Additionally, copies of all contracts and agreements should be in this section of the due diligence data room. If you company has intellectual property or patents, copies of all employee and company documents related to ownership of corporate intellectual property should be included in the legal due diligence data room.

    Much of the content of the Legal due diligence data room section will be defined by the law firm that is assisting in reviewing the legal documents associated with the sale of the company. It is important that the legal due diligence section include any and all past legal documents that could reoccur as become issues in future. If you fail to disclose a relevant legal issue you could be at risk of a future law suit.


    Operational Due Diligence

    The operational due diligence section of the data room should contain well documented overviews of the processes associated to the operation of the business. Business relationships, suppliers and distribution channels should also be clearly documented. The buyer/investor will be looking for areas of risk such as a single supplier that could affect ongoing success. Another area of concern would be an unbalanced sales distribution network where one channel has a disproportionate amount of channel sales.

    The seller should also include a summary of their business plan in the due diligence data room with emphasis on the next 1-3 year business plan and how improved efficiencies, additional products, expanded distribution will increase revenue and net profit. This business plan should also be referenced in the financial due diligence section.

    Another important data point for the due diligence data room is web traffic and the size of not only the customer database but also the size of potential customers in the email marketing database.

    The prospective buyer may look for ways to eliminate expenses once the transaction is complete. The desire will be to identify changes that will result in an increase in EBITDA. Prospective buyers will also be interested in international operations and associated agreements.
     


    IT and Intellectual Due Diligence

    The IT Due Diligence data room area should include a detailed listing of all IT systems used in the normal business processes. If the company is a Software Development company or has developed any software for internal all of these programs should be documented in detail. Any use of third party software of software contracts should also be documented. Any use of “open source” software should also be included in the IT due diligence data room.

    Any patents or trademarks should be included in this section of the due diligence data room. The company’s internet presence should be documented including information on ecommerce, web hosting and online customer records.

    Procedure and overview documents should cover such topics as, security, backup procedures, controls, and auditing. Remember, the one of the objectives of the due diligence data room is to present enough information to remove any and all concerns a prospective buyer might have. Unanswered questions translate to undefined risk which translates to lower offers. A buyer that believes he has a COMPLETE understanding of all facets of a prospective business will have lower risk concerns and thus be more willing to submit an offer that is at the top end of his valuation model.
     


    Personnel Due Diligence

    Documents contained in the Personnel Due Diligence data room area should include an Org Chart of all management, a Bio/Resume for each executive, a resume on each critical employee (key developers, designers, programmers, etc.), wages and salary contracts for all executives and key employees. This section should also contain any and all HR, benefits, and compensation contracts and policies.

    The Personnel Due Diligence area of the data room is often where issues arise that could potentially result in deal not closing. Some examples of “deal breakers” might include, unresolved sexual harassment issues, key management who might leave if salary and benefit programs are altered. Undocumented oral agreements on future perks or stock options that will be distributed after the acquisition.

    Buyers will likely look for positions or division that could be eliminated to reduce operating costs. Care should be made to document and understand the value of each key person/department to ensure ongoing success of the business.

     

     




     

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