Tuesday, July 19, 2011

Lesson #66: Preparing for a Due Diligence Process

Whether you are selling your business or raising new capital from professional venture capitalists, you are most likely going to be required to prepare for, and complete, an exhaustive due diligence process on your business.  So, the sooner you can prepare for such process, before you start it, the better off you will be.  Due diligence usually revolves around questions about the business and questions of about your financials.  I will summarize the high level topics you should expect below.

Business information requests will include things like: (i) organizational documents (e.g,. charter, operating agreement, board minutes, ownership chart, list of managers, lists of investors); (ii) key customers/suppliers (e.g., top 10 customers, top 10 suppliers, key relationships); (iii) litigation (e.g, all pending, settled or threatened lawsuits; (iv) key contracts (e.g., standard forms, non-competes, joint ventures, acquisitions, oral agreements, material breaches); (v) regulatory matters (e.g., violations of any government regulations for environment, employment and anti-trust, business licenses, regulatory filings, workers' compensation history, employee training documents; (vi) insurance matters (e.g., list of all active/cancelled policies, claims history); (vii) employee matters (e.g, list of all employees, salaries, hire dates, benefit plans, employment agreements, employee handbook/policies, tax status); and (viii) security/data protection (e.g., policies, procedures, credit card compliance, technical firewalls, password access, disaster recovery).  

Financial information requests will include things like: (i) debt obligations (e.g, lines of credit, bonds, investor notes); (ii) historical and projected financial statements (e.g., income statement, balance sheet, cash flow, accounting policies, A/P and A/R aging schedules); (iii) tax matters (e.g., federal/state/city income filings, sales, payroll, unemployment, abandoned assets/property, tax sharing agreements); (iv) key assets/property/liens of the business (e.g., real estate, leases, mortgages, appraisals, titles); and (v) intellectual property (e.g., patents, trademarks, copyrights, owned software, licensed software, domain names)

By no means is the above intended to represent an all-encompassing due diligence list, as investors/buyers may ask for much more than what is listed above, depending on the depth of their due diligence process.  And, as you can see, this process can be quite time consuming (both in preparing the requested materials and educating the investor/buyer on such information), and it will certainly distract you from your core business for a couple months.  But, hopefully, you are keeping clean files, as part of your everyday normal operations, to make this process less painful than it could be, by having to create a data room from scratch.

And, worth mentioning, the same due diligence list that is being asked of you, as a seller, can be used by you, as a buyer in any acquisitions you are considering.  So, keep this lesson handy to make sure you are asking the right questions of any acquisition targets.

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