M&A 101: Due Diligence Basics (Part 1)

Due Diligence Checklist“Due diligence” is the term applied to the research and investigation that go into determining precisely what your company would be purchasing when acquiring another business. It is essential to know this information up front, as it can directly affect the purchase price and terms.

The decision on whether or not to purchase a business should be made with the head, not the heart. For this reason due diligence requires an organized and methodical approach. While due diligence requirements will vary with the type and size of the target business, there are basic checklists that can help you organize your approach to identifying the assets (both tangible and intangible) you’ll be acquiring. We’ll start with taking a look at the hard assets.

Receivables

  • Review the target company’s aged accounts receivable schedule to identify receivables that may be uncollectible
  • Review receivables to assess the collectability of larger balances, and to identify larger customers and the status of their account
  • Uncover any significant receivable owed by related parties, such as company owners or officers, family members, or business controlled by them
  • Determine if receivables have been factored or used as collateral for borrowing purposes without being properly booked as liabilities

Intellectual Property

  • If intangible assets or intellectual property are part of the transaction, consult with a qualified attorney to verify the rights and ownership, and to evaluate the strength of patents, trademarks, licenses, etc.

Inventory

  • If applicable, perform physical inventory to establish the existence, scope, and condition of inventory items, and to identify obsolete items that may remain in inventory and on the books
  • Review work-in-progress inventory values to be sure they are not overstated
  • Compare book inventory value to insured values
  • Determine if inventories have been borrowed against without being properly booked as liabilities

Equipment

  • Conduct a physical inventory of equipment listed as part of the transaction
  • Review repair and maintenance records to determine if needed work has been delayed or postponed to inflate current operating results
  • Have equipment values professionally appraised
  • Compare book equipment values to insured values
  • Determine if receivables have been borrowed against without being properly booked as liabilities

Real Estate

  • Conduct a title search to verify ownership of real estate and the possible existence of undisclosed mortgages and liens
  • Check public records for tax liens and other liens against the properties
  • Hire a professional appraiser to value real property assets
  • Compare estimated fair market values to insured values and property tax assessments
  • If applicable, hire an environmental engineer to assess possible environmental liabilities associated with real estate assets
  • Determine if mortgages with favorable terms can be assumed

In a future blog post, we’ll examine the detective work necessary to uncover potential liabilities and operational issues that could affect the value and performance of the business you are acquiring. Gray, Gray & Gray’s Merger & Acquisition Group can help you set up due diligence procedures that are specific to your needs. Please contact us at (781) 407-0300.

 

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