Posted by Kris Tabetando | December 26, 2014
This piece follows the article on the important legal due diligence process you must perform when you intend to acquire a technology company. You can read the preceding article here: Checklist for Performing Legal Due Diligence of a Technology Business.
So you’re looking to acquire a technology company. You’ve looked at a number of prospects, identified a suitable candidate, and both the buyer and seller have executed a letter of intent.
Now you’re in the due diligence phase. This involves a thorough legal, financial, and strategic review of the company.
The seller’s team will prepare the business documents that the buyer’s team requests. The buyer’s team will review these documents and ask pertinent follow-up questions.
This due diligence process will either confirm or refute the value proposition upon which the transaction strategy was built. It will determine whether it makes sense to move forward with the deal or not.
LEGAL DUE DILIGENCE versus BUSINESS DUE DILIGENCE
In the previous article Checklist for Performing Legal Due Diligence of a Technology Business, we established that there are 2 types of due diligence that you must perform: Legal Due Diligence and Business Due Diligence.
The buyer’s legal due diligence team focuses on the legal issues in the transaction. These include a variety of matters from reviewing intellectual property rights to employee and supplier contracts.
The buyer’s business due diligence team focuses on the financial and strategic issues in the transaction. These include diverse matters such as reviewing the business operations and confirming that business synergies are real.
In this article, we’ll focus on the checklist for the business due diligence process.
CHECKLIST FOR BUSINESS DUE DILIGENCE
The amount of due diligence performed at this stage will depend on the knowledge and experience of the buyer’s team in the industry in which the business operates.
For example, a financial buyer who is new to the industry will have to do more due diligence than a strategic buyer who knows the business or industry pretty well.
Every technology business is unique. Every M&A transaction is unique. As such, a checklist should always be tailored to fit the specific transaction. The checklist below will cover most areas. But it must be tailored to fit your particular deal.
1. Business Overview
– When was the business launched?
– Where is it headquartered?
– What is the legal business name?
– Which province or state is the business registered in?
– What is the company structure (C, LLC, etc)?
– Excluding the head office, list other office locations
– In the simplest terms, what does the business do?
2. Products or Services
– List all the business’ products or services
– List the product breakdown by revenues in the last fiscal year
3. Manufacturing & Distribution
– How are the products manufactured and distributed?
– Are the production or distribution methods proprietary?
– Is production at 100% capacity all year round?
– Is the business cyclical or seasonal?
– Are fixed assets such as machinery and equipment in good working condition?
– When will these fixed assets need to be replaced?
– What are the business’ inventory levels?
– When will inventory need to be replenished?
– What key raw materials or resources are needed in the production process?
– What are the biggest costs in the production process?
– What are the biggest costs in the distribution process?
In pure software businesses, manufacturing and physical distribution may be irrelevant. In that case, human intellectual capital is the most important asset to the business.
4. Human Resources
– How many full-time staff does the business have?
– How many part-time staff does the business have?
– How many contractors does the business have?
– How many sales representatives does the business have?
– How many technology professionals does the business have?
– How many support staff does the business have?
– How many total staff members are at each office location?
– Who are the top 10 customers?
– List the customer breakdown by revenues in the last fiscal year
– Does the business depend on many small customers or a few large customers?
6. Sales Pipeline
– What pending or closed contracts are in the pipeline?
– List estimated or actual dollar values for each contract
– List estimated or actual expected close dates for each contract
A sales pipeline would apply to a technology business that is driven by a salesforce that goes out and obtains contracts that the business operations staff fulfill.
Analyzing the sales pipeline enables the buyer to forecast future revenues that he would receive if he acquired the business.
7. Sales & Marketing
– How does the business advertise or promote its products?
– Is it a salesforce-driven or marketing-driven business?
– What percentage of revenues is spent on advertising or the saleforce?
– Is the percentage comparable with the industry averages?
– Who are the main suppliers or partners?
– Does the business have any long-term contracts with any suppliers or partners?
– Who are the top 5 competitors?
– What differentiates the target business from these competitors?
10. Industry Sectors
– List the industry sectors that the business serves
The business may have most of its big customers concentrated in a specific sector such as financial services, aerospace, government, healthcare, etc.
– List the industry breakdown by revenues in the last fiscal year
11. Geography Served
– List the geographical regions that the business serves
The business may have most of its big customers concentrated in a specific geographical area.
– List the geography breakdown by revenues in the last fiscal year
12. Certifications & Awards
– List all the certifications or awards that the business has received (if applicable)
Certifications can be extremely important in certain industries such as with IT solutions providers. Without certain certifications, the business may not be eligible to bid on certain types of IT contracts offered by businesses and government agencies.
13. Growth Plans
– What are the growth plans set by the business managers?
– Does the business have sufficient capital to pursue these growth plans?
If prior to putting the business up for sale, the managers had mapped out a growth plan, it’s important for the new owner to review the plan.
14. Financial Analysis
– Study the business revenues, expenses, and earnings numbers & trends
– Compare these ratios to the industry averages
– How current are the business’ account receivables?
– What are the business’ main financial liabilities and debt obligations?
– What are the business’ monthly debt service payments?
In order for the buyer to protect himself against hidden liabilities, he can ask the seller to sign an affidavit regarding liabilities.
In this document, the seller explicitly details all liabilities (if any) and the affidavit outlines how the buyer will be compensated by the seller if any hidden or omitted liabilities are uncovered in the future.
15. Industry Outlook
– What’s the industry outlook?
– Is the industry growing, stable, or declining?
– What is the business’ market share?
– How is the business’ performance relative to the industry averages in the different sections above?
– Where do the biggest opportunities for growth lie in this industry?