The process of due diligence is something that in the process of mergers and acquisitions the buyer conducts to confirm the accuracy of the seller’s claims. A potential M&A deal involves several types of due diligence.
Types of Due Diligence
The main types of due diligence inquiry are as follows:
Administrative DD is the aspect of due diligence that involves verifying admin-related items such as facilities, occupancy rate, number of workstations, etc. The idea of doing due diligence is to verify the various facilities owned or occupied by the seller and determine whether all operational costs are captured in the financials or not. Admin DD also gives a better picture of the kind of operational cost the buyer is likely to incur if they plan to pursue expansion of the target company.
One of the most important types of due diligence is the financial due diligence that seeks to check whether the financials are accurate or not. Financial DD aims to provide a thorough understanding of all the company’s financials, including, but not restricted to, audited financial statements for the last three years, recent unaudited financial statements with comparable statements of the last year, the company’s projections and the basis of such projections, capital expenditure plan, schedule of inventory, debtors and creditors, etc.
Another type of due diligence conducted is asset DD. Asset due diligence reports typically include a detailed schedule of fixed assets and their locations (if possible, physical verification should be done), all lease agreements for equipment, a schedule of sales and purchases of major capital equipment during the last three to five years, real estate deeds, mortgages, title policies, and use permits.
Human Resources DD
Human resources due diligence is extensive. It may include all of the following:
- Analysis of total employees, including current positions, vacancies, due for retirement, and serving notice period
- Analysis of current salaries, bonuses paid during the last three years, and years of service
- All employment contracts, with nondisclosure, non-solicitation, and non-competition agreements between the company and its employees. In case there are a few irregularities regarding the general contracts, any questions or issues need to be clarified. etc…
Due diligence in regard to tax liability includes a review of all taxes the company is required to pay and ensuring their proper calculation with no intention of under-reporting of taxes. Additionally, verify the status of any tax-related case pending with the tax authorities.
Intellectual Property DD
Almost every company has intellectual property assets that they can use to monetize their business. These intangible assets are something that differentiates their products and services from their competitors. They may often comprise some of the company’s most valuable assets. A few of the items that need to be looked at in a due diligence review are:
- Schedule of patents and patent applications
- Schedule of copyrights, trademarks, and brand names
- Pending patents clearance documents
- Any pending claims case by or against the company in regard to violation of intellectual property.
Acquirers are generally also very careful about exercising due diligence in regard to evaluating how well the target company fits in with the overall strategic business plan of the buyer. For example, a private equity firm considering a new acquisition will ask how well the proposed target will complement the firm’s existing portfolio of companies.
In a proposed merger or a situation where shares of stock in the acquiring company constitute a major part of the purchase transaction, the target company may look to perform its own due diligence on the acquirer.