Atlantic Canada's Business Transition Specialist

SINCE 1998

Due Diligence

Due Diligence: The Deal is Almost Done – Or is it?

The Letter of Intent has been signed by both buyer and seller and everything seems to be moving along just fine. It would seem that the deal is almost done. However, the due diligence process must now be completed. Due diligence is the process in which the buyer really decides to go forward with the deal, or, depending on what is discovered, to renegotiate the price – or even to withdraw from the deal. So, the deal may seem to be almost done, but it really isn’t – yet!

It is important that both sides to the transaction understand just what is going to take place in the due diligence process. The importance of the due diligence process should not be underestimated. Stanley Foster Reed in his book, The Art of M & A, wrote, “The basic function of due diligence is to assess the benefits and liabilities of a proposed acquisition by inquiring into all relevant aspects of the past, present, and predictable future of the business to be purchased.”

Depending upon the size and complexity of the business involved, prior to the due diligence process, buyers may decide to assemble experts to assist in this phase. These might include appraisers, accountants, lawyers, environmental and operational experts, marketing personnel, etc. Many buyers fail to add an operational person familiar with the type of business under consideration. The legal and accounting side may be fine, but a good fix on the operations themselves is very important as a part of the due diligence process. After all, this is what the buyer is really buying.

Since the due diligence phase does involve both buyer and seller, here are some of the main items for both parties to consider.

Human Resources:  Review names, positions and responsibilities of the key management staff. Also, check the relationships, if appropriate, with labour, employee turnover and incentive and contractual arrangements.

Income and other Taxes:  Review income tax returns, assessment notices and any audit results as well as other filings including those for employee remittances and workers’ compensation.
Operations:  Review Policy and Procedure Manuals to ensure that they are adequate, complete and up-to-date.

Balance Sheet:  These areas should especially be reviewed: Accounts receivables should be checked for aging, who is paying and who is not, bad debt and the reserves. Inventory should be checked for work in process, finished goods along with turnover, non-usable inventory and the policy for returns and/or write offs.

Environmental Issues:  Ground contamination, ground water issues, lead paint and asbestos issues are all reasons for deals not to close, or at least to not to close on a timely basis.

Facilities and Equipment:   Does the facility work efficiently? How old and serviceable is the machinery and equipment? Is the technology still current? Are the facilities and equipment sufficient to generate the anticipated financial results?

Trademarks, Patents & Copyrights:  Are these intangible assets transferable and in whose name are they? In today’s business world where intangible assets may be the backbone of the company, the deal is generally based on the satisfactory transfer of these assets.

Due diligence can determine whether the buyer goes through with the deal or begins a new round of negotiations. By completing the due diligence process, the buyer insures as far as possible, that he or she is getting what they bargained for. The executed Letter of Intent is, in many ways, just the beginning.

by Stewart Baker