What is due diligence?
Due diligence is a transaction that involves checking the potential seller’s business. The parties are the buyer or investor and seller. Due diligence is said to be an arduous process. Rigorous analysis of company data and testing for viability in the market takes time and resources.
Still, after that, the buyer can make an informed decision, making sure of:
- the authenticity of the information provided by the seller;
- the absence of shortcomings affecting the transaction;
- reliable information about the value assessment;
- complying with the principal criteria and standards
Due diligence is necessary for mergers and acquisitions, restructuring, asset purchases, etc.
To conduct an audit, the parties need to know about the fundamental characteristics that govern this operation.
- Confidentiality. Strict confidentiality of information between the parties, complying with data protection regulations.
- Involvement of third parties for a transparent audit. There are specific companies that perform due diligence.
- A clear goal. That is to discover the contingencies of the other party.
- Recent data. The data obtained during the check cannot be out-of-date. It is the basis for a buyer’s decision.
Now let’s move on to the stages:
- The first step is the creation of a team that is in charge of the deal
- Data-collection for verification. The group of people conducting the audit may request any documents relevant to the case.
- Thorough analysis. During the check, there may be reasons for changing the terms of the deal or its cancellation.
- Drawing up a report, the content of which no one can influence. Here all the essential information about the target company is open. Having examined this document, the buyer decides to conclude / not conclude a transaction.
Who can carry out the procedure
To save money, some companies conduct due diligence on their own. They engage specialists from their departments. The advantages of this approach:
- reduction in the cost of the procedure;
- the experts have in-depth professional knowledge in the field of their company;
- the ability to see the business from the inside
- identify possible risks and make recommendations for their elimination
The disadvantages of not using external consultants are:
- distracting employees from operational tasks;
- performing due diligence independently only when acquiring a business in a similar area;
- the biased attitude to facts
Independent due diligence is advisable only in small companies. That is because a comprehensive analysis of a large business requires qualified specialists and also a lot of time.
Even professional investors and banks with first-class experts often invite law firms.
International and regional companies, as well as small consulting agencies, deliver services for due diligence. The advantage of an integrated approach is that the entire due diligence package belongs to the client on a turnkey basis.
Data rooms for due diligence
Data rooms usually serve as secure storage for confidential business papers. The creation takes place under the supervision of a legal council. The lawyer chosen by the company not only provides legal support during the conclusion. This person makes a list of documents to place them afterward in the data room according to the topic.
Types of data rooms for due diligence
This type is one of the most common sections. The financial sector always implies a large volume of information. Data rooms keep it organized and secure for both parties. There is information that covers the last few years. The buyer studies the documents in detail to detect risks in advance. And what is also significant, there are financial forecasts for the current year. Some organizations provide this kind of report for the next few years. A seller should include data only on sales that have a clear perspective. Otherwise, the transaction may not comply with the terms of the contract.
A checklist of required documents is good support for the seller. Buyers and investors demand this data. By using the list on this website, the seller’s side is unlikely to miss anything important.
The content of the data room is a yardstick of the performance and value of the company. Thus, the potential buyer evaluates the organization having useful insights.
This data room is also full of an enormous amount of essential documentation, including meeting minutes. Information about the type of property and those persons who are the owners must be open here. During the transaction, the buyer or investor should have access to copies of the contracts on the platform. If there is intellectual property, all relevant documents are available in the due diligence data room.
The legal team, which participates in the examination, reviews the content related to the sale of the company. In the process of creating a data room, the organization is obliged to provide all documents that are potential problems in the future. Otherwise, the company (the seller) faces legal action from the side of the buyer or investor.
This type of data room consists of documents related to the operation of an enterprise. There are reports on partnerships, supplies and suppliers, distribution channels. During the transaction, the buyer’s side carefully examines the possible risks that threaten negative consequences in the future. Another problem that attracts the attention of the buyer is the distribution of sales if it is unbalanced.
The due diligence data room should contain a report on the company’s business plan for the coming years (for example, 1-3 years). There is also information about the likely increase in efficiency, business development, and increased income. It is also necessary to provide data on the size of the client base, present, and potential.
Investors often resort to EBITDA when evaluating a company. With the help of this indicator, it is possible to determine whether a company in the future will be able to reinvest funds, develop its business, and service its debt obligations. International transactions and contracts are also of interest to investors and buyers.
This data room contains a list of all information systems that the enterprise uses in its work. Suppose an organization develops software. It documents in detail all data related to the development and operation of such programs. In case of their use by third parties, the organization provides information about this. Open-source software is no exception. Along with e-commerce, resources for hosting information on servers, a customer database.
Keeping the prospective buyer free of all doubts and worries is one of the main goals of the data room due diligence. The seller’s side must convince the buyer of the reliability, data backup, control. That is possible due to the data provided on the platform. Lack of information leads to doubts. Accordingly, the purchase price falls. The fuller and more eloquent the data room is, the better the chances of a successful deal are.
This data room provides the following information:
- data on all managers in the form of biographies or resumes;
- employee contracts that include payroll information;
- compensation agreement
Personnel’s due diligence process often raises issues that jeopardize the close of the deal. For example, key executives resign due to pay changes or other innovations.
The buyer sometimes looks for a way to get rid of some positions or even departments. The aim is to reduce costs. Appropriate attention to documents, managers, and departments assures a buyer of the integrity and success of the business.