Business-savvy buyers and sellers do their best to influence the other party to take action. Prior to an exchange, it is necessary to conduct appropriate research to gain a full understanding of what you are getting yourself into. In a court of law, agents exercise due diligence to avoid harm to other persons or their property. In the business world, individuals practice due diligence through research and analysis of an organization or person before partaking in a transaction. Due diligence establishes a standard of care. Learning how to properly perform due diligence produces an optimal outcome.
Bring in the Experienced Business Experts
A surefire way to safeguard your assets and eliminate any possible risks it to enlist professional help. Keep in mind, working with a lawyer, accountant or business advisor may be expensive. However, this additional help can eliminate any opportunity cost associated with your time spent. Mergers & acquisition specialists or other related professionals will not only ameliorate the process as a whole, but will alleviate the pressure placed upon upper management.
In-depth research needs to be conducted on the other company and related personnel that you intend to do business with, similar to how companies perform background checks on prospective employees. You want to avoid working with a company that has a history of fraud or poor performance ratings, so doing your homework at this step is crucial. Aside from investigating a company’s financials, you want to analyze the amount of time the other company dedicates to directors’ meetings, existing contracts, number of employees and customers, details about plant, property and equipment (PP&E), existing partnerships and leases. The buyer needs to be aware of every business-related function and how the business is forecasted to perform. The buyer should also have a thorough understanding of why the other business wants to merge or sell. Why do they not want to continue operations on their own? What has begun to slow them down? Will any challenges translate to your business? No information should go undiscovered. Research any legal trouble the company might have and ensure that it will have no impact upon you.
Arguably the most important aspect of due diligence is performing a complete evaluation of the selling company’s financial records. The following list pinpoints some of the key documents that need to be examined:
- Income Statements
- Balance Sheet and Tax Returns
- Record of Accounts Payable and Receivable
- Profit/Loss Records
- Statement of Cash Flows
- Bank Loans and Lines of Credit
- Audit Work Files (If Available)
- Stock History
Obtaining and performing an extensive analysis of these documents will reveal the most information about the other party. Income statements will provide insight to profit margins, revenue trends, and cash flows. If the company is in a financial state of decay, the buyer will know immediately and can potentially forgo the acquisition. Numbers will also provide an approximate valuation for how much revenue is forecasted in the future.
The balance sheet will be equally as important when determining the health of the business. Balance sheets and tax returns should be examined dating back to a minimum of five years to better visualize any possible fluctuations. If there are extreme variations in the financial documents, the buyer should know why. When merging, outstanding debt is acquired therefore it is vital to discover any hidden liabilities and certify that all assets and liabilities are valued accurately. Additionally, there should be ample capital available to pay off any short-term liabilities. If available, the stock history will further divulge the company’s performance by showcasing any volatility that suggests risk and by indicating the number of stock owners. Inspecting these financials will reveal the company’s past and will grant the buyer a better expectation of its future.
Review the Industry
After gaining an understanding of the other party’s internal environment, you need to assess its external environment. Reviewing trends in the industry along with the company’s market share will assist any forecasted numbers. Managers will be able to assess the barriers to entry, the level of regulation, concentration level, competition and the industry’s life cycle stage. Paired with a promising external structure, even a relatively poor performing business can seem attractive to others. If, however, the industry is in a state of decline, it may be wise to not invest as much capital.
Red Flags and Warning Signs
Mergers and acquisitions stand as one of the more impactful, yet risky moves in the business world. Due to the severity of the situation, some parties may want to finalize a deal as soon as possible. Although this may be enticing, timing should not be the most important factor. Here are some warning signs to watch for while going through the process of due diligence:
- Failure to disclose all information
- No introduction to suppliers or estate agent
- Disallowing a trial period
- Questionable credit record
- Involved in legal disputes
- Anxious to accelerate a deal
Acknowledgment of these signs should result in hesitation on the buyer’s part. Having a testing period to see how the other company will fit with your corporate culture can have a profound impact upon your success. If at any moment the other party arouses suspicion, you need to conduct more research and ask questions to figure out why.
Finalizing the Deal
Due diligence serves to give insight to the performance and potential of another company. Upon completion, you should have a realization of how this company will fit into your existing strategy and impact your vision moving forward. If the pairing does not seem like the right match, move forward to the next opportunity. The combination of outside assistance paired with internal efforts to perform due diligence will establish a fair negotiated price and help transcend your business to the next level.