Types of Due Diligence

Ways to assess a company's capabilities and financial performance

What are the Types of Due Diligence?

One of the most important and lengthy processes in an M&A deal is Due Diligence. The process of due diligence is something which the buyer would like to conduct to confirm the accuracy of the seller’s claims. A potential M&A deal involves several types of due diligence.

 

Types of Due Diligence

 

Types of Due Diligence

Due diligence (DD) is an extensive process to completely understand a business capability and its performance. The main types of due diligence are:

 

1. Administrative DD

Administrative DD is one of the types of due diligence that involves verifying admin-related items such as facilities, occupancy rate, number of workstations, vacancy rate, etc. The idea of doing due diligence is to verify the various facilities owned by the seller company and whether all costs are captured in the financials or not. It also gives a better picture of the kind of cost the buyer is going to incur in case they plan to go for expansion.

 

2. Financial DD

One of the most important types of due diligence as it seeks to check whether the financials showcased in the Confidentiality Information Memorandum (CIM) is correct or not. It also provides a deep understanding of all the company’s financials, including but not restricted to audited financial statements for last three years, recent unaudited financial statements with comparable statements of last year, the company’s projection and basis of such projections, capital expenditure plan, schedule of inventory, debtors and creditors, etc. Also, the process involves analysis of major top customer accounts, fixed and variable cost analysis, analysis on gross margins, customers with high profit margins and their contract period, internal control procedures, etc. It will also involve the type of the company’s order book and sales pipeline to better build projections. 

 

3. Assets DD

A detailed schedule of fixed assets and its locations (if possible physical verification should also be done); all lease agreements regarding various equipment, schedule of sales and purchases of major capital equipment during last three years, real estate deeds, mortgages, title policies and other permits.

 

4. Human Resource DD

  • Analysis of total employees, including current positions, vacancy, due for retirement and serving notice period
  • Analysis of current salaries, bonuses paid during 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, focus must be given.
  • HR policies regarding annual leave, sick leave and other forms of leave
  • Analysis of employee problems for alleged wrongful termination, harassment, discrimination and any legal case pending about the same
  • In case there are labor disputes, requests for arbitration, or grievance procedures currently pending, its financial impact needs to be seen
  • A list and description of all employee health benefits and welfare insurance policies or self-funded arrangements
  • ESOPs and schedule of grants

 

Due Diligence Process

 

5. Environmental DD

Diligence related to environmental regulation is very important because if the company violates any major rule, local authorities can exercise their right to penalize and cancel its operational right. Hence, this makes the environmental audits for each property leased by the company an important one. The following should be reviewed carefully:

  • List of environmental permits and licenses and validities of the same
  • Soft or hard copies of all correspondence and notices with EPA, state, or local regulatory agencies
  • Whether the company’s disposal methods are in sync with the regulated guidelines
  • Whether there are any contingent environmental liabilities or continuing indemnification obligations. 

 

6. Taxes DD

Diligence on various taxes the company is required to pay and ensuring their proper calculation with no intention of under-reporting of taxes. Status of any tax-related case running with the tax authorities. 

 

7. Intellectual Property DD

Almost every company owns IPs that they can use to monetize their business. These IPs are something that differentiates their product and service from their competitors. Few of the items that need to be seen are:

  • Schedule of patents and its application
  • Schedule of copyrights, trademarks and brand names
  • Pending patents clearance documents
  • Any pending claims case by or against the company in violation of intellectual property

 

8. Legal DD

  • Copy of Memorandum and Articles of Association
  • Minutes of Board Meeting for the last three years
  • Minutes of all meetings or actions of shareholders for the last three years
  • Copy of share certificates issued to Key Management Personnel
  • Copy of all guarantees to which company is a party
  • All material contracts
  • Copies of all loan agreements, bank financing agreements, line of credit to which company is a party

 

9. Customer DD

  • Company’s top customers in terms of sales and the details of the contracts to make sure that no unwanted liability arises
  • Service agreements and sufficient insurance coverage against them
  • Credit policy for the customers and charges that is applicable to them
  • Unfulfilled order book
  • Customer Satisfaction Score and related reports for last two or three years
  • List and explanation of any major customer loss over the last two years

 

Related Resources

CFI offers the Financial Modeling & Valuation Analyst (FMVA)™ certification program for those looking to take their careers to the next level. To keep learning and advancing your career, the following resources will be helpful:

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