Basic Questions on Due Diligence

Transcription

1 Success Stories Professional Resources Businesses for Sale Website Creative Business Services has served Wisconsin for over 31 years. As one of the leading business brokerage and mergers and acquisitions advisory firms in the state, we continue to provide the best possible service to our clients. Due Diligence - you have thought about it - but what is it. Once your buyer has negotiated an acceptable offer to purchase with you, the seller, he now starts to learn all about the particulars and details of your business including any skeletons that maybe lurking. Prepare ahead of time for the Due Diligence. Once you have decided to divest your business, be proactive and think of what the buyer is going to be concerned about. In effect, put the buyers hat on and closely evaluate all the items of significance a buyer will want to analyze before the acquisition. Basic Questions on Due Diligence What is Due Diligence? Due diligence is used to investigate and evaluate a business opportunity. The term due diligence describes a general duty to exercise care in any transaction. As such, it spans investigation into all relevant aspects of the past, present, and predictable future of the business of a target company. MORE - see pages 2-4 Michael J. Schwantes Principal, Certified Business Intermediary (CBI) and Graduate of the Realtors Institute (GRI), founded Creative Business Services in Questions or comments? me at mschwantes@cbs-global.com Buying a Business: Due Diligence Checklist So you have decided to purchase an existing business. Regardless of whether the deal is structured as an asset transaction, a stock transaction or a merger, make sure you know what you are getting into by requiring detailed information from the seller regarding its business operations and finances. The following is a checklist of information and documents you should review. MORE - see page 5-8 Creative Business Services 319 N Broadway Green Bay, WI corporate@cbs-global.com Due Diligence -- Do It Now! Due diligence is generally considered an activity that takes place as part of the selling process. It might be wise to take a look at the business from a buyer s perspective in performing due diligence as part of an annual review of the business. Performing due diligence does two things: (1) It provides a valuable assessment of the business by company management, and (2) It offers the company an accurate profile of itself, just in case the decision is made to sell, or an acquirer suddenly appears at the door. MORE - see page 9-10 Your business is important to us. Please share any feedback with us and feel free to pass this newsletter on to friends and business associates.

2 Basic Questions on Due Diligence What is Due Diligence? Due diligence is used to investigate and evaluate a business opportunity. The term due diligence describes a general duty to exercise care in any transaction. As such, it spans investigation into all relevant aspects of the past, present, and predictable future of the business of a target company. Due diligence sounds impressive but ultimately it translates into basic commonsense success factors such as "thinking things through" and "doing your homework". Why is Due Diligence Conducted? There are many reasons for conducting due diligence, including the following: Confirmation that the business is what it appears to be; Identify potential "deal killer" defects in the target and avoid a bad business transaction; Gain information that will be useful for valuing assets, defining representations and warranties, and/or negotiating price concessions; and Verification that the transaction complies with investment or acquisition criteria. Who Conducts Due Diligence? Lead and co-investors, corporate development staff, attorneys, accountants, investment bankers, loan officers and other professionals involved in a transaction may have a need or an obligation to conduct independent due diligence. Target management typically assists these parties in obtaining due diligence information but because it is unwise to totally rely on management third party consultants such as Astute Diligence are often brought in to conduct due diligence. When is Due Diligence Conducted? Initial data collection and evaluation commences when a business opportunity first arises and continues throughout the talks. Thorough detailed due diligence is typically conducted after the parties involved in a proposed transaction have agreed in principle that a deal should be pursued and after a preliminary understanding has been reached, but prior to the signing of a binding contract. Continued on page N. Broadway, Green Bay, WI p: f: corporate@cbs-global.com 2

3 Continued from page 2 How is Due Diligence Conducted? The parties conducting due diligence generally create a checklist of needed information. Management of the target company prepares some of the information. Financial statements, business plans and other documents are reviewed. In addition, interviews and site visits are conducted. Finally, thorough research is conducted with external sources -- including customers, suppliers, industry experts, trade organizations, market research firms, and others. How Much Due Diligence Needs to Be Conducted? There is no correct answer to this question. The amount of due diligence you conduct is based on many factors, including prior experiences, the size of the transaction, the likelihood of closing a transaction, tolerance for risk, time constraints, cost factors, and resource availability. It is impossible to learn everything about a business but it is important to learn enough such that you lower your risks to the appropriate level and make good, informed business decisions. Can I Overdo My Due Diligence Effort? Yes. Too much due diligence can offend a target company to the point where they walk away from a deal. It can also result in "analysis paralysis" that prevents you from completing a transaction or provides time for a better competing offer to emerge. Accordingly, it is important that due diligence be prioritized and executed expeditiously. Appropriate investigation and verification into the most important issues often must be balanced by a sensible level of trust concerning lesser issues. How Much Time is Allocated for Due Diligence Completion? Time allocated for completion can vary widely with each situation. Many preliminary agreements define the timeframes in which due diligence will be conducted. Time schedules through the closing of a transaction are typically tight -- parties should ensure that adequate time is allocated to due diligence. How Should I Prioritize Tasks Within the Due Diligence Effort? Every transaction will have different due diligence priorities. For example, if the main reason you are acquiring a company is to get access to a new product they are developing to accelerate your own time to market, then the highest priority task is to ensure that the product is near completion, that there are no major obstacles to completion, and that the end product will meet your business objectives. In another transaction, the highest priority might be to ensure that a major lawsuit is going to be resolved to your satisfaction. Continued on page 4

4 Continued from page 3 How Much Does Due Diligence Cost? Who Pays for It? Due diligence costs are based on the scope and duration of the effort, which in turn are dependent on the complexity of the target business and other factors. Costs are typically viewed as an essential expense far outweighed by the anticipated benefits and the downside risks of failing to conduct adequate due diligence. The involved parties determine who will bear due diligence expense. How Do You Maintain Confidentiality During a Due Diligence Engagement? Certain activities conducted during due diligence can breach confidentiality that a transaction is being contemplated. For example, contacting a customer to assess their satisfaction with the target company's products might result in a rumor spreading that the company is up for sale. Accordingly, to maintain confidentiality, we often contact customers under the guise of being a prospective customer, journalist, or industry analyst. Does Due Diligence Ensure that a Business Transaction Will Be Successful? A well-run due diligence program cannot guarantee that a business transaction will be successful. It can only improve the odds. Risk cannot be totally eliminated through due diligence and success can never be guaranteed. Can I Be Sued for Failing to Conduct Adequate Due Diligence? In this litigious world, you can be sued for just about anything and failing to conduct due diligence is no exception. Parties involved in a business transaction may find themselves being sued by their clients, investors, customers, employees, suppliers, or other third parties asserting failure to conduct proper due diligence or pursuing a liability that was overlooked or incorrectly assessed by due diligence. Can Using a Due Diligence Consultant Ensure that I Will Not Be Sued? No. However, conducting proper due diligence may serve as a strong legal defense to third-party claims after a transaction closes. Due diligence may also reduce legal issues by alerting a purchaser or investor to potential liabilities that can be mitigated in various ways prior to closing the transaction. Source: 4

5 Buying a Business: Due Diligence Checklist So you have decided to purchase an existing business. Regardless of whether the deal is structured as an asset transaction, a stock transaction or a merger, make sure you know what you are getting into by requiring detailed information from the seller regarding its business operations and finances. The following is a checklist of information and documents you should review. A. Organization and Good Standing. The Company's Articles of Incorporation, and all amendments thereto. The Company's Bylaws, and all amendments thereto. The Company's minute book, including all minutes and resolutions of shareholders and directors, executive committees, and other governing groups. The Company's organizational chart. The Company's list of shareholders and number of shares held by each. Copies of agreements relating to options, voting trusts, warrants, puts, calls, subscriptions, and convertible securities. A Certificate of Good Standing from the Secretary of State of the state where the Company is incorporated. Copies of active status reports in the state of incorporation for the last three years. A list of all states where the Company is authorized to do business and annual reports for the last three years. A list of all states, provinces, or countries where the Company owns or leases property, maintains employees, or conducts business. A list of all of the Company's assumed names and copies of registrations thereof. B. Financial Information. Audited financial statements for three years, together with Auditor's Reports. The most recent unaudited statements, with comparable statements to the prior year. Auditor's letters and replies for the past five years. The Company's credit report, if available. Any projections, capital budgets and strategic plans. Analyst reports, if available. A schedule of all indebtedness and contingent liabilities. A schedule of inventory. A schedule of accounts receivable. A schedule of accounts payable. A description of depreciation and amortization methods and changes in accounting methods over the past five years. Any analysis of fixed and variable expenses. Any analysis of gross margins. The Company's general ledger. A description of the Company's internal control procedures. Continued on page N. Broadway, Green Bay, WI p: f: corporate@cbs-global.com 5

6 Continued from page 5 C. Physical Assets. A schedule of fixed assets and the locations thereof. All U.C.C. filings. All leases of equipment. A schedule of sales and purchases of major capital equipment during last three years. D. Real Estate. A schedule of the Company's business locations. Copies of all real estate leases, deeds, mortgages, title policies, surveys, zoning approvals, variances or use permits. E. Intellectual Property. A schedule of domestic and foreign patents and patent applications. A schedule of trademark and trade names. A schedule of copyrights. A description of important technical know-how. A description of methods used to protect trade secrets and know-how. Any "work for hire" agreements. A schedule and copies of all consulting agreements, agreements regarding inventions, and licenses or assignments of intellectual property to or from the Company. Any patent clearance documents. A schedule and summary of any claims or threatened claims by or against the Company regarding intellectual property. F. Employees and Employee Benefits. A list of employees including positions, current salaries, salaries and bonuses paid during last three years, and years of service. All employment, consulting, nondisclosure, non-solicitation or noncompetition agreements between the Company and any of its employees. Resumes of key employees. The Company's personnel handbook and a schedule of all employee benefits and holiday, vacation, and sick leave policies. Summary plan descriptions of qualified and non-qualified retirement plans. Copies of collective bargaining agreements, if any. A description of all employee problems within the last three years, including alleged wrongful termination, harassment, and discrimination. A description of any labor disputes, requests for arbitration, or grievance procedures currently pending or settled within the last three years. A list and description of benefits of all employee health and welfare insurance policies or self-funded arrangements. A description of worker's compensation claim history. A description of unemployment insurance claims history. Copies of all stock option and stock purchase plans and a schedule of grants there under. Continued on page 7 6

7 Continued from page 6 G. Licenses and Permits. Copies of any governmental licenses, permits or consents. Any correspondence or documents relating to any proceedings of any regulatory agency. H. Environmental Issues. Environmental audits, if any, for each property leased by the Company. A listing of hazardous substances used in the Company's operations. A description of the Company's disposal methods. A list of environmental permits and licenses. Copies of all correspondence, notices and files related to EPA, state, or local regulatory agencies. A list identifying and describing any environmental litigation or investigations. A list identifying and describing any known superfund exposure. A list identifying and describing any contingent environmental liabilities or continuing indemnification obligations. I. Taxes. Federal, state, local, and foreign income tax returns for the last three years. States sales tax returns for the last three years. Any audit and revenue agency reports. Any tax settlement documents for the last three years. Employment tax filings for three years. Excise tax filings for three years. Any tax liens. J. Material Contracts. A schedule of all subsidiary, partnership, or joint venture relationships and obligations, with copies of all related agreements. Copies of all contracts between the Company and any officers, directors, 5-percent shareholders or affiliates. All loan agreements, bank financing arrangements, line of credit, or promissory notes to which the Company is a party. All security agreements, mortgages, indentures, collateral pledges, and similar agreements. All guaranties to which the Company is a party. Any installment sale agreements. Any distribution agreements, sales representative agreements, marketing agreements, and supply agreements. Any letters of intent, contracts, and closing transcripts from any mergers, acquisitions, or divestitures within last five years. Any options and stock purchase agreements involving interests in other companies. The Company's standard quote, purchase order, invoice and warranty forms. All nondisclosure or noncompetition agreements to which the Company is a party. All other material contracts. Continued on page 8 7

8 Continued from page 8 K. Product or Service Lines. A list of all existing products or services and products or services under development. Copies of all correspondence and reports related to any regulatory approvals or disapprovals of any Company's products or services. A summary of all complaints or warranty claims. A summary of results of all tests, evaluations, studies, surveys, and other data regarding existing products or services and products or services under development. L. Customer Information. A schedule of the Company's twelve largest customers in terms of sales thereto and a description of sales thereto over a period of two years. Any supply or service agreements. A description or copy of the Company's purchasing policies. A description or copy of the Company's credit policy. A schedule of unfilled orders. A list and explanation for any major customers lost over the last two years. All surveys and market research reports relevant to the Company or its products or services. The Company's current advertising programs, marketing plans and budgets, and printed marketing materials. A description of the Company's major competitors. M. Litigation. A schedule of all pending litigation. A description of any threatened litigation. Copies of insurance policies possibly providing coverage as to pending or threatened litigation. Documents relating to any injunctions, consent decrees, or settlements to which the Company is a party. A list of unsatisfied judgments. N. Insurance Coverage. A schedule and copies of the Company's general liability, personal and real property, product liability, errors and omissions, key-man, directors and officers, worker's compensation, and other insurance. A schedule of the Company's insurance claims history for past three years. O. Professionals. A schedule of all law firms, accounting firms, consulting firms, and similar professionals engaged by the Company during past five years. Source: 8

9 Due Diligence -- Do It Now! Due diligence is generally considered an activity that takes place as part of the selling process. It might be wise to take a look at the business from a buyer s perspective in performing due diligence as part of an annual review of the business. Performing due diligence does two things: (1) It provides a valuable assessment of the business by company management, and (2) It offers the company an accurate profile of itself, just in case the decision is made to sell, or an acquirer suddenly appears at the door. This process, when performed by a serious acquirer, is generally broken down into five basic areas: Marketing due diligence Financial due diligence Legal due diligence Environmental due diligence Management/Employee due diligence Marketing Issues It has been said that many company officers/ceos have never taken a look at the broad picture of their industry; in other words, they know their customers, but not their industry. For example, here are just a few questions concerning the market that due diligence will help answer: What is the size of the market? Who are the industry leaders? Does the product or service have a life cycle? Who are the customers/clients, and what is the relationship? What are the downside and the upside of the product/service? What is the risk and potential? Financial Issues Two important questions have to be answered before getting down to the basics of the financials: (1) Do the numbers really work? and (2) Are the seller s claims supported by the figures? If the answer to both is yes, the following should be carefully reviewed: The accounts receivables The accounts payable The inventory Legal Issues Are contracts and agreements current? Are products patented, if necessary? How about copyrights and trademarks? What is the current status of any litigation? Are there any possible law suits on the horizon? What would an astute attorney representing a buyer want to see and would it be acceptable? Continued on page N. Broadway, Green Bay, WI p: f: corporate@cbs-global.com 9

10 Continued from page 9 Environmental Issues Not too long ago this area would have been a non-issue. Not any more! Current governmental guidelines can levy responsibility regarding environmental issues that existed prior to the current occupancy or ownership of the real estate. Possible acquirers and lenders are really gun-shy about these types of problems. Management/Employee Issues What employment agreements are in force? What family members are on the payroll? Who are the key people? In other words, who does what, why, and how much are they paid? Operational Issues The company should have a clear program covering how their products are handled from raw material to out the door. Service companies should also have a program covering how services are delivered from initial customer contact through delivery of the services. The question is, do you give your company a physical now, or do you wait until someone else does it for you with a lot riding on the line? Source: 10