A due diligence checklist is an organized way to analyze a company that you are acquiring through sale, merger, or another method. By following this checklist, you can learn about a company’s assets, liabilities, contracts, benefits, and potential problems. Due diligence checklists are usually arranged in a basic format. However, they can be changed to fit different industries.
Table of Contents
Why Is a Due Diligence Checklist Important?
The main reason you need a due diligence checklist is to make sure you don’t overlook anything when acquiring a business. Having a due diligence checklist allows you to see what obligations, liabilities, problematic contracts, intellectual property issues, and litigation risks you’re assuming. Most of the documents and information on your due diligence checklist is available on request. Once you have the information, it’s up to you to analyze it and decide whether it’s a good investment.
Company sales, mergers, and acquisitions should all follow the same checklist to avoid unforeseen issues. Sellers might also create a reverse diligence checklist to analyze the buyer.
What Should I Have in My Due Diligence Checklist?
A due diligence checklist for an affiliate website, a productized service, a SaaS, or an ecommerce store will have it’s own look and feel. For many reasons, the checklist must be custom tailored to the transaction. Below is a list of some common due diligence categories for middle-market transactions.
Important: Many of these items may not be relevant to your transaction. This is simply meant as an informative guide for your own due diligence checklist.
Antitrust and Regulatory Issues
- Any potential antitrust issues as a result of the purchase.
- A list of any prior regulatory or antitrust issues.
- A list of Department of Commerce filings.
Information Technology Concerns
- A list of software used by the company.
- A list of software licenses bought to analyze other companies.
- The current system usage and age of equipment.
- Outsourcing agreements with IT companies.
- The software’s level of customization.
- A list of interfaces that link systems together.
- An analysis of the system. Legacy systems often need maintenance. From this analysis, you can choose to keep the current system or replace it.
- An outline of a disaster recovery plan should systems crash or become damaged.
- Articles and press releases about the company within the last three years.
- A list of all independent professionals that have worked with the company within the past five years. This includes accountants, lawyers, and consultants.
- A copy of insurance claims over the past three years.
- A schedule and copy of the company’s insurance coverage, such as:
- Worker’s compensation
- General liability
- Personal and property
- Directors and officers
- Errors and omissions
- Product Liability
- Intellectual Property
- A list of all pending litigation.
- Descriptions of threatened litigation.
- A list of unsatisfied judgments.
- Documents about injunctions or settlements.
- Copies of insurance policies that protect against litigation.
- History of problems with regulatory bodies such as the SEC or IRS.
- A review of all board minutes, shareholder minutes, and audit minutes.
Product and Services
- Lists of products and services offered.
- Lists of products and services in development.
- Correspondence and documents related to regulatory approval of product line.
- Summary of complaints.
- Summary of warranty claims.
- Tests, evaluations, studies, and surveys about products or services under development.
- A list of major customers and product applications.
- Profitability and cost structure, including:
- Expense trends over the past five years.
- Questionable expenses that you can cut.
- Employee loans. This might include pay advances or long-term loans.
- Fixed assets.
- If a company owns many fixed assets, it could show a reactive approach to market trends.
- Valuation, inspection, maintenance, utilization, and replacement rate are all topics to know about fixed assets.
- Speed and nature of change within the industry.
- List and description of competitors, including strengths, weaknesses, market position, and basis of competition.
- Current ad programs, marketing budgets, and printed marketing materials.
- Research on ways to get new business.
- A list of distribution channels, marketing opportunities, and marketing risks.
- Surveys and market research on company products.
- A comparative analysis.
- This shows how the company’s marketing efforts stack up against competitors.
- It should also show the company’s dedication to creating a brand.
- A schedule of the company’s 12 to 20 largest customers, as well as sales within the last two years for each.
- Issues about keeping customers after the sale.
- A description of the company’s credit policies.
- A description of the company’s purchasing policies.
- Supply and service agreements.
- A schedule of unfilled orders.
- A list and explanation of any major customers lost within the past two years.
- A list of strategic relationships or partnerships.
- Revenue listed by customer
- A list of the top 10 suppliers, as well as business deals within the past two years.
- Federal, state, local, and foreign tax returns for the past three years, including net loss or profit.
- A list of any tax liens.
- State sales tax returns for the last three years.
- Excise tax filings for three years.
- Audit reports.
- Employment tax filings for past three years.
- This shows if the company pays a lump sum or quarterly taxes.
- You can also see if the company is paying the correct amount in taxes.
- Tax settlement documents over the past three years.
- Detailed explanations of general accounting principles.
- A schedule of financing for debt and equity.
- A list of undisclosed tax liabilities.
- Monthly manufacturing yields.
- Agreements and relationships with any subsidiaries, partnerships, or joint ventures.
- Copies of contracts between the company and directors, officers, affiliates, and minimum 5 percent shareholders.
- Loan agreements including promissory notes, financing details, and lines of credit.
- All nondisclosure and noncompete agreements.
- A list of mortgages, collateral pledges, indentures, and security agreements.
- Installment sales agreements.
- Guarantees involving the company on any level.
- Copies of quote, invoice, purchase, and warranty forms.
- Distribution, sales, marketing, and supply agreements.
- Contracts, transcripts, or letters of divestitures from any merger or acquisition within the past five years.
- Options and stock purchase agreements affecting company operations.
- Off-balance sheet liabilities.
- Explanation of supply chain and supply restrictions.
- Transportation costs.
- A list of inventory systems to track incoming and outgoing goods and find obsolete goods.
- Power of attorney agreements.
- Exclusivity agreements.
- Franchise agreements.
- Indemnification agreements.
Licenses and Permits
- Copies of federal, state, and local licenses, permits, and consent forms.
- Any documents about proceedings with a regulatory agency.
- A list describing or identifying any environmental liabilities or contingencies.
- A list of hazardous materials used in production.
- A list of any superfund exposure.
- Copies of notices and filings with the Environmental Protection Agency (EPA).
- A list of all environmental investigations and pending litigation.
- Environmental audits for each company property.
- A description of company disposal methods for hazardous materials, recyclables, etc.
- A list of terminated licenses or permits.
- Costs for environmental compliance.
- Listings of all owned or leased property and locations.
- Copies of deeds, mortgages, real estate leases, title policies, and zoning approvals.
- A list of Uniform Commercial Code (UCC) filings.
- A list of leased equipment.
- A list of major equipment sales and purchases over the past three years.
- A schedule of fixed assets with locations.
Intellectual Property (Trade Secrets, Copyrights, Patents, Trademarks)
- A list of foreign and domestic patent applications.
- A list of copyrights.
- A list of trademarks and trade names both domestic and abroad.
- A description of methods used to protect trade secrets.
- Descriptions of all technical information within the company.
- Patent clearance documents.
- Work-for-hire agreements.
- Summary of claims or threatened claims on intellectual property.
- Copies of all consulting agreements, invention agreements, and licenses of intellectual property to and from the company.
- A list of all licensing revenue and expenses.
Employees and Benefits
- Copies of stock purchase and stock option benefits for employees.
- Worker’s compensation claims history.
- Unemployment claims history.
- List of employees and their positions, current salaries, years of service, and total compensation over the past three years.
- An explanation of the company’s salary philosophy.
- Pay history and pay freeze information, which helps you decide if current employees will expect a raise soon.
- All nondisclosure, noncompete, and nonsolicitation agreements between employees and company.
- Resumes, history, and experience of key employees such as senior level management.
- A list of union affiliations and contracts.
- List and description of all employee health and welfare insurance policies.
- Descriptions of any labor disputes, arbitration, or grievances settled or outstanding over the past three years.
- Copies of collective bargaining agreements.
- Evidence of compliance with IRS Section 409A in regards to stock options.
- Evidence of compliance with IRS Section 280G in connection with the purchase.
- A list of any officers in criminal or civil litigation.
- Actuarial reports for the past three years.
- Layoff and severance package information.
- A list of harassment, wrongful termination, and discrimination disputes within the past three years.
- A copy of the employee handbook including policies on vacation, sick days, benefits, holidays, and paid leave. This allows you to compare your current situation with others in the industry.
- Turnover data for the past two years.
- Documents on pension plan funding and distributions.
- Copies of all Occupational Safety and Health Administration (OSHA) examinations.
- The results of formal and informal employee surveys.
Organization and Good Standing of Company
- The Articles of Incorporation and any amendments.
- A list of company bylaws and amendments.
- A list of company assumed names.
- A list of all states or countries where the company does business, has employees, or owns/leases an asset.
- Annual reports for the last three years.
- A copy of the company’s minute book.
- An organizational chart.
- A list of all shareholders and percentages owned.
- A Certificate of Good Standing from each Secretary of State where the company does business.
- Active status reports in the state of incorporation over the past three years.
- Agreements on voting trusts, subscriptions, puts, calls, options, and convertible securities.
- Audited financial statements (cash flow, balance sheet, income statement, footnotes) for the last three years, including an auditor’s report and quarterly and annual statements.
- Auditor’s correspondence for the past five years. These are letters sent to management that outline areas to improve profits and efficiency.
- Unaudited financial statements for comparison.
- Company credit report.
- A schedule of accounts receivable
- A schedule of accounts payable. Check these for any overdue or unpaid accounts that might impact profit.
- An aging schedule of accounts payable and accounts receivable.
- A list of outstanding debt.
- Search for any clauses that increase debt if a company is sold.
- Scan for any related parties that have loaned money to the company. This includes manager, investors, and shareholders.
- A list of unrecorded liabilities, which you usually find when interviewing the seller or employees.
- A list of collateral for debt.
- A schedule of depreciation and amortization methods over the past five years.
- Analysis of gross margins.
- Analysis of fixed and variable expenses.
- A list of the company’s internal control procedures.
- A list of assets and liabilities.
- A schedule of inventory.
- Projections, capital budgets, and strategic plans.
- Projections should include revenue by product type, customer, and channel.
- Projections should also include all financial statements such as a balance sheet, cash flow statement, and cash-on-hand.
- A list of growth drivers and possible clients and customers.
- Industry and company pricing plans.
- Analysis of projected expenditures and depreciation.
- Any perceived risk in foreign markets such as inflation, political strife, and exchange rates.
- The general ledger.
- Analyst reports.
- Breakdown of sales and gross profits by geography, channel, and product type
- Planned projection vs. actual sales chart.
- Capital structure.
- Current shares outstanding.
- A list of all stockholders with options, warrants, and notes.
- A list of non-operational expenses. Many companies put operating expenses in this category to pad their earnings.
- Public filings. If the company is publicly traded, it must file a Form 10-K annual report, Form 10-Q quarterly report, and other issues on the Form 8-K. You can get these from the Securities and Exchange Commission (SEC) website.
- Recurring revenue stream. This is a key value driver from the company. It shows loyal customers and how much they bring to the business.
- Backlog. Creating a monthly backlog of the past year shows true revenue. It also shows decreasing or increasing revenue trends.
- Pricing philosophy. This lets you know how the company prices its goods or services.
- Estimating philosophy. If the company has a special order, it should have an estimate department. Analyzing this provides you with a detailed list of profit or loss.
Other Issues to Consider
- How is the company organized?: A company’s organization structure is key for liquidity and return on an investment. Potential incorporations include an LLC, LP, C-Corp, and S-Corp.
- Does the corporate structure foster growth?
- Who is on the board of directors?: You need a board of directors whose goals are in line with your own.
- Does the company do its financial auditing in-house or outsource it?
- Are revenues realistic?
- What is the current and potential market size?
- Interview all employees.
- Conduct an independent competitive analysis.
- Consult a tech firm.
- Conduct independent market analysis.
- Review all financial documents.
- Interview board members, consultants, and advisers.
Please Note: The above list is relatively comprehensive. Many items will not be relevant to your transaction. This is simply a guide to help you create your own due diligence checklist.
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