Due diligence: Horrendous settlement amounts, additional tax demands or complicated customer relationships – the purchase of a company involves many risks. The due diligence process is therefore a necessity for the buyer if he does not want to buy a pig in a poke.
What does due diligence mean?
Due diligence describes the accurate, systematic and detailed data collection, data analysis and data review of the target. In simpler terms, this refers to the detailed examination and analysis of a company carried out by a potential buyer. The focus is on the economic, legal, tax and financial circumstances of the company for sale.
Goals of the due diligence
A purchase offer always refers to certain assumptions and conditions relating to the company to be acquired.
To make sure that this information is true, the buyer can have relevant data checked with the help of experts and external consultants. In this way, all risks can be reliably identified and disclosed.
Of course, the duration of a due diligence review depends on the size and target market of the company. A major international corporation is likely to have much more data to submit for inspection than a small store with 3 employees.
Why is due diligence important?
Specifically, we are talking about 4 forms of risk that must be avoided. Companies should secure support from technical management consultants, tax advisors, auditors and technical experts to avoid making mistakes in the complexity of the undertaking. Furthermore, it is advisable to automate the due diligence process with the help of special software and thus achieve a continuous risk assessment.
1. legal risks
This area includes protection against money laundering and corruption, verification of business cooperation and subcontractors in international business. For international activities, the regulations of the UK Bribery Act or FCPA are binding here. For activities within a country, other regulations come into force, e.g. those of the GWG.
2. financial risks
Should the business partner or the business acquisition prove to lack integrity, the buyer will be subject to high penalties and, in the worst case, even imprisonment. It is therefore essential to analyze the financial risks in detail before a corporate transaction.
3. risks that damage the company’s image
If a company is associated with criminal, unfair or incorrect methods or behavior, this has the most severe negative effects on its public image. Example: If a well-known fashion company becomes known for its dubious working conditions in China, it loses its good reputation and has to initiate a variety of measures to make up for this damage to its reputation. .
4. economic risks
Logically, the purchase or merger of companies and organizations directly affects the economic situation of the buyer. That is why a due diligence check is nowadays a compulsory program when taking over or buying a company.
Different contents or sub-forms of due diligence
Depending on the thematic focus, various subtypes of due diligence are subdivided. Usually, some or all of the subforms are combined to obtain optimal results.
- Legal due diligence deals with ownership, corporate documents, commercial filings, bylaws and contracts, employment and service agreements, litigation and the like.
- Tax due diligence includes tax and balance sheet matters, e.g. balance sheet policy, tax risks and the tax transaction structure consequences.
- Financial due diligence is used to assess the financial situation: assets, capital structure, liquidity and so on.
- Market Due Diligence (Business Opportunity, Commercial Due Diligence) focuses on the position within the industry, selling proposition and other strategic aspects. In addition, the focus is on opportunities and risks in future markets.
- Management due diligence examines management quality in terms of credentials, training and expertise.
- Exit due diligence is mainly represented in the field of venture capital. The exit channels and their conditions should thus be identified.
- Environmental due diligence has the task of finding out whether potential environmental risks arise from the investment.
Generally, a due diligence process includes several successive phases.
This has the advantages that…
the business processes of the target company are not disrupted
can be cancelled quickly in the event of contradictions
the transaction expense is reduced
The results of the individual analyses and reviews are finally compiled in a due diligence report. The report is then studied by the founders and managers on the buy side.
Due Diligence Checklist
A due diligence checklist should provide indications of what information the buyer needs. It serves much more as a general example than concrete guidance. For this reason, everyone should seek professional help before making a business purchase. The advisor knows exactly which items on the checklist are important for which business forms and goals.
The essential points of a due diligence checklist are:
1. finances (tax due diligence)
2. rights (legal due diligence)
3. personnel management (personnel due diligence)
4. customers (customer due diligence)
5. competition (commercial due diligence)
6. technology (technical due diligence)