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What are Due Diligence Checks & How to Conduct Them Properly

Kison Patel
CEO and Founder of DealRoom
Kison Patel

Kison Patel is the Founder and CEO of DealRoom, a Chicago-based diligence management software that uses Agile principles to innovate and modernize the finance industry. As a former M&A advisor with over a decade of experience, Kison developed DealRoom after seeing first hand a number of deep-seated, industry-wide structural issues and inefficiencies.

CEO and Founder of DealRoom

When you are acquiring new businesses, it's crucial to make a check of the business health of the company you're about to become an owner of.

After all, all obligations, liabilities, and financial burden will quickly become your problem which is why you should conduct successful due diligence checking if you don't want to regret your business decisions.

We at DealRoom help dozens of companies utilize due diligence checking and in this article we'll explain:

  • due diligence checking meaning
  • how to conduct due diligence checks
  • types of due diligence checks
  • due diligence checks check list

What is a due diligence checking?

A due diligence checking is an investigation or audit of a potential investment consummated by a prospective buyer. It's simply a set of questions that let you thoroughly evaluate a company or project.

By going through these questions (or checks), you'll have the chance to explore all the finer details — from understanding financial situation of a company, to evaluating the social impact and many more.

Importance of due diligence checks

In the world of business, especially in relationships with your financial partners, it is important to understand everything about the company and its core competencies.

This can make or break a deal that could see you reap huge rewards.

Due diligence checking is an extensive review of all available public and private information on a given subject. It's critical that businesses perform due diligence audits before each investment or business transaction — after all, doing so will ensure they don't run into unnecessary risks down the road.

Who conducts due diligence checks?

Due diligence in its core is conducting a thorough investigation when making a business decision like purchasing shares or buying a business.

Equity research firms, fund managers, and analysts at private investment banks all use due diligence as part of their evaluation process — digging into financial performance metrics, management and corporate structure, legal filings, and more.

At the same time, individual investors are free to conduct their own due diligence on securities before acquiring them.

While you can do your own due diligence when you want to buy assets, stocks, or even buy USDT (since most of the information is public), it's often not suggested that you do this procedure for business and private companies, as there are many "in-between" situations that requires help of professionals.

due diligence software

Due diligence check types

There are many ways to categorize due diligence but we will try to simplify the process by showing the three most important types: commercial, financial, and legal.

These three are the cornerstone for any investor who is trying to tap into a new company and enter a new market.

1. Commercial due diligence

A commercial due diligence report is a written document that serves to provide potential buyers with a complete and accurate understanding about the company, including its history and growth, as possible.

Buyers can take this information and use it to establish whether or not they wish to proceed with the purchase. It's crucial to know what you're getting in order to give a proper business proposal.

It will tell you a lot about branding, company value in the eyes of the customers, etc.

2. Financial due diligence

Financial due diligence is an investigative analysis of the financial situation that a company finds itself in. There are many reasons to conduct it — from increasing revenue, to suppressing risk or even making investments.

While some companies do it themselves, most others use outside sources for a more accurate picture of the company portfolio.

Suppose you're about to acquire a company. In that case, it's crucial to have a clear picture of the financial results and know of any potential financial burden, such as a bad credit score, significant debts, or diminishing revenues.

3. Legal due diligence

Companies should always perform legal due diligence before making important decisions — especially when it comes to mergers and acquisitions.

The deal will most likely be expensive, so every part of your target company needs to be considered.

Intellectual property infringements, IP rights, and any other information that can actually benefit your potential target company is crucial to know beforehand.

Due diligence check list

1. Legal Due Diligence Checks

  • Shareholder certificate documents
  • Local/state/federal business licenses
  • Occupational license
  • Building permits documents
  • Zonal and land use permits
  • Tax registration documents
  • Power of attorney documents
  • Previous or outstanding legal cases

2. Financial Due Diligence Checks

  • Up to date tax returns documents
  • Audited financial statements (at least 3 years)
  • Auditor's correspondence for last five years
  • Copies of all loans and credit agreements
  • Details of company investments (bonds, marketable securities, etc.)
  • Capital structure
  • Projections, capital budgets, and strategic plans
  • Up to date tax and pension liabilities
  • Details on when contracts and leases are renewed and whether the terms change
  • Details of stockholders (percentage holdings, voting rights, etc.)
  • Foreign exchange reserves
  • List of unrecorded liabilities
  • List of collateral for debt
  • Details of owner withdrawals (if any)
  • Revenue by client (if possible)
  • Gross margins analysis
  • Fixed/variable expenses analysis
  • List of non-operational expenses
  • General ledger

Find out more with financial due diligence checklist.

3. Sales and Marketing Due Diligence Checks

  • Detailed overview of sales and marketing strategy
  • Marketing/sales coordination protocols
  • Revenue listed by customer
  • Exhibit relationship between marketing expense and revenue growth
  • Details of existing sales contracts (and when they expire)
  • List of top 10 suppliers
  • Sales reports by category of product or service
  • Details of credit terms with customers
  • Current market share (if possible)
  • Percentage of sales owing to each sales channel (e.g. online, offline, direct sales, etc.)

4. Human Resources Due Diligence Checks

  • Provide a list of current employees and independent contractors
  • Employee rules of conduct handbook and safety policies
  • Detail past employee disputes (if any)
  • Detail employee and independent contractor terms of employment
  • Detail updated employee resumes
  • Outline policy of working with labor union (if any)
  • Outline training conducted with existing employees
  • Worker's compensation/unemployment claims history
  • Outline policy of bonuses, incentives, commissions and deferred commissions
  • Detail policies for sick days, paid holidays, paid vacations and overtime pay

5. Property, Plant, and Equipment Due Diligence Checks

  • Equipment
  • Real estate
  • Technology
  • Inventory

6. Contract Due Diligence Checks

  • Customer contracts
  • Supplier contracts
  • Joint venture/partnership agreements
  • Settlement agreements
  • Franchising agreements
  • Accounts receivable schedule
  • Accounts payable schedule
  • Equipment leases
  • Non-compete agreements
  • Employee contacts
  • Loans, credits, and guaranties agreements

7. Intellectual Property Due Diligence Checks

  • Trade secrets
  • IP claims and litigation
  • Domain names
  • Issued patents
  • Patent applications
  • Design patents
  • Design patent applications
  • Industrial designs
  • Industrial design applications
  • Liens on intellectual property
  • Copyrights
  • Licenses
  • Licensing agreements
  • Trademarks
  • Agreements/documents regarding ownership and rights of use of advertising copy, trade-marks, logos, and slogans

8. Company's Good Standing and Organization Due Diligence Checks

  • Organizational Chart
  • Shareholders/percentages owned
  • Voting trusts, subscriptions, calls, puts, options, and convertible securities agreements
  • State of incorporation status reports for the last three years
  • Assumed names
  • Company minutes book
  • Company bylaws and amendments
  • List of the states and countries where the company has employees, owns assets, leases assets, and does business
  • The Articles of Incorporation/amendments.
  • Annual reports for the last three years.
  • A Certificate of Good Standing from each Secretary of State where the company conducts business

Summary

You cannot trust words.

While everyone will try to sell themselves for as much as possible, you're looking for a way to maximize your profits if you're acquiring a company.

Due diligence checks have to be done properly, without rushing, and most importantly: with external, non-related to both organizations, analytical experts who can provide an accurate picture of the financial results of a company, estimate the commercial value and potential growth, and analyze any potential legal issues that may arise.

due diligence template

When you are acquiring new businesses, it's crucial to make a check of the business health of the company you're about to become an owner of.

After all, all obligations, liabilities, and financial burden will quickly become your problem which is why you should conduct successful due diligence checking if you don't want to regret your business decisions.

We at DealRoom help dozens of companies utilize due diligence checking and in this article we'll explain:

  • due diligence checking meaning
  • how to conduct due diligence checks
  • types of due diligence checks
  • due diligence checks check list

What is a due diligence checking?

A due diligence checking is an investigation or audit of a potential investment consummated by a prospective buyer. It's simply a set of questions that let you thoroughly evaluate a company or project.

By going through these questions (or checks), you'll have the chance to explore all the finer details — from understanding financial situation of a company, to evaluating the social impact and many more.

Importance of due diligence checks

In the world of business, especially in relationships with your financial partners, it is important to understand everything about the company and its core competencies.

This can make or break a deal that could see you reap huge rewards.

Due diligence checking is an extensive review of all available public and private information on a given subject. It's critical that businesses perform due diligence audits before each investment or business transaction — after all, doing so will ensure they don't run into unnecessary risks down the road.

Who conducts due diligence checks?

Due diligence in its core is conducting a thorough investigation when making a business decision like purchasing shares or buying a business.

Equity research firms, fund managers, and analysts at private investment banks all use due diligence as part of their evaluation process — digging into financial performance metrics, management and corporate structure, legal filings, and more.

At the same time, individual investors are free to conduct their own due diligence on securities before acquiring them.

While you can do your own due diligence when you want to buy assets, stocks, or even buy USDT (since most of the information is public), it's often not suggested that you do this procedure for business and private companies, as there are many "in-between" situations that requires help of professionals.

due diligence software

Due diligence check types

There are many ways to categorize due diligence but we will try to simplify the process by showing the three most important types: commercial, financial, and legal.

These three are the cornerstone for any investor who is trying to tap into a new company and enter a new market.

1. Commercial due diligence

A commercial due diligence report is a written document that serves to provide potential buyers with a complete and accurate understanding about the company, including its history and growth, as possible.

Buyers can take this information and use it to establish whether or not they wish to proceed with the purchase. It's crucial to know what you're getting in order to give a proper business proposal.

It will tell you a lot about branding, company value in the eyes of the customers, etc.

2. Financial due diligence

Financial due diligence is an investigative analysis of the financial situation that a company finds itself in. There are many reasons to conduct it — from increasing revenue, to suppressing risk or even making investments.

While some companies do it themselves, most others use outside sources for a more accurate picture of the company portfolio.

Suppose you're about to acquire a company. In that case, it's crucial to have a clear picture of the financial results and know of any potential financial burden, such as a bad credit score, significant debts, or diminishing revenues.

3. Legal due diligence

Companies should always perform legal due diligence before making important decisions — especially when it comes to mergers and acquisitions.

The deal will most likely be expensive, so every part of your target company needs to be considered.

Intellectual property infringements, IP rights, and any other information that can actually benefit your potential target company is crucial to know beforehand.

Due diligence check list

1. Legal Due Diligence Checks

  • Shareholder certificate documents
  • Local/state/federal business licenses
  • Occupational license
  • Building permits documents
  • Zonal and land use permits
  • Tax registration documents
  • Power of attorney documents
  • Previous or outstanding legal cases

2. Financial Due Diligence Checks

  • Up to date tax returns documents
  • Audited financial statements (at least 3 years)
  • Auditor's correspondence for last five years
  • Copies of all loans and credit agreements
  • Details of company investments (bonds, marketable securities, etc.)
  • Capital structure
  • Projections, capital budgets, and strategic plans
  • Up to date tax and pension liabilities
  • Details on when contracts and leases are renewed and whether the terms change
  • Details of stockholders (percentage holdings, voting rights, etc.)
  • Foreign exchange reserves
  • List of unrecorded liabilities
  • List of collateral for debt
  • Details of owner withdrawals (if any)
  • Revenue by client (if possible)
  • Gross margins analysis
  • Fixed/variable expenses analysis
  • List of non-operational expenses
  • General ledger

Find out more with financial due diligence checklist.

3. Sales and Marketing Due Diligence Checks

  • Detailed overview of sales and marketing strategy
  • Marketing/sales coordination protocols
  • Revenue listed by customer
  • Exhibit relationship between marketing expense and revenue growth
  • Details of existing sales contracts (and when they expire)
  • List of top 10 suppliers
  • Sales reports by category of product or service
  • Details of credit terms with customers
  • Current market share (if possible)
  • Percentage of sales owing to each sales channel (e.g. online, offline, direct sales, etc.)

4. Human Resources Due Diligence Checks

  • Provide a list of current employees and independent contractors
  • Employee rules of conduct handbook and safety policies
  • Detail past employee disputes (if any)
  • Detail employee and independent contractor terms of employment
  • Detail updated employee resumes
  • Outline policy of working with labor union (if any)
  • Outline training conducted with existing employees
  • Worker's compensation/unemployment claims history
  • Outline policy of bonuses, incentives, commissions and deferred commissions
  • Detail policies for sick days, paid holidays, paid vacations and overtime pay

5. Property, Plant, and Equipment Due Diligence Checks

  • Equipment
  • Real estate
  • Technology
  • Inventory

6. Contract Due Diligence Checks

  • Customer contracts
  • Supplier contracts
  • Joint venture/partnership agreements
  • Settlement agreements
  • Franchising agreements
  • Accounts receivable schedule
  • Accounts payable schedule
  • Equipment leases
  • Non-compete agreements
  • Employee contacts
  • Loans, credits, and guaranties agreements

7. Intellectual Property Due Diligence Checks

  • Trade secrets
  • IP claims and litigation
  • Domain names
  • Issued patents
  • Patent applications
  • Design patents
  • Design patent applications
  • Industrial designs
  • Industrial design applications
  • Liens on intellectual property
  • Copyrights
  • Licenses
  • Licensing agreements
  • Trademarks
  • Agreements/documents regarding ownership and rights of use of advertising copy, trade-marks, logos, and slogans

8. Company's Good Standing and Organization Due Diligence Checks

  • Organizational Chart
  • Shareholders/percentages owned
  • Voting trusts, subscriptions, calls, puts, options, and convertible securities agreements
  • State of incorporation status reports for the last three years
  • Assumed names
  • Company minutes book
  • Company bylaws and amendments
  • List of the states and countries where the company has employees, owns assets, leases assets, and does business
  • The Articles of Incorporation/amendments.
  • Annual reports for the last three years.
  • A Certificate of Good Standing from each Secretary of State where the company conducts business

Summary

You cannot trust words.

While everyone will try to sell themselves for as much as possible, you're looking for a way to maximize your profits if you're acquiring a company.

Due diligence checks have to be done properly, without rushing, and most importantly: with external, non-related to both organizations, analytical experts who can provide an accurate picture of the financial results of a company, estimate the commercial value and potential growth, and analyze any potential legal issues that may arise.

due diligence template

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