Since I started investing, I’ve learnt a great deal – mainly through making mistakes and learning from them, but also by planning and preparing. The most recent iteration of my investment strategy includes a due diligence checklist; which I’ve decided to write about here. This list isn’t an exhaustive list of everything I might request or discuss, but is usually a starting point for any investment opportunity which I’m in the process of reviewing.
Due diligence is the formal process of validating claims and assets of a target acquisition made during an investment investigation. There are usually lawyers involved with the purpose for doing background checks on the founders and company contacts. There are also usually accountants involved to review the historical and projected financial information, the tax filings, and check the accuracy.
Every investor has their own formula for carrying out due diligence on an acquisition. Some request all the information at once, in detailed documentation, while others request information at different times and stages of the process. What is important is that you as an investor receive sufficient checks and assurances that what you are buying is what you expect! There are always multiple follow-up questions which arise during the process and these could take up to several weeks to satisfy. Again, make sure that you receive sufficient answer to these to allow you to proceed with the process.
Whenever I’m making an investment, I take the mentality that the better prepared I am, the better equipped I am to get the maximum ROI on my investment. If the first twelve months of an investment are full of surprises, my focus won’t be on growing the return, but on fire fighting to keep the investment alive. As with many things, a simple checklist is often the most straight forward and efficient way of preparing, and my due diligence checklist is included below;
Viola Enterprises – Due Diligence Checklist
1. General Background
- History of the company (as well as that if any previous trading names).
- The company’s short- and long-term objectives.
- The company’s financial needs
- The company’s competitive advantage
2. Management and Human Resources
- Organizational chart, including a complete list of the Management Team and the Board of Directors.
- A complete list of all professional advisers involved; lawyer, accountant, consultants etc.
- Are there any employment agreements? If so, what are they?
- Are there any confidentially agreements? If so, what are they?
- What are the DOB, NI and addresses of main principles on board? (Background check)
- Company size (number of employees)
- Is there a company handbook? If so, get a copy.
- What are the staffing and key resource requirements? Are there any current, or anticipated changes?
3. Products or Services Offerings
- How will customers use the product or service?What benefit(s) will the customers value from the product or service?
- How does the product or service compare on; Price, quality, availability, credit terms, competitiveness and servicing?
- Is there patent, trademark or trade secret protection? If so, who owns it and where is it valid?
4. Market Conditions
- What is the demand? Is it organic or manufactured?
- Is the market a mature one?
- What are the current and historical trends in the industry?
- Are there any geographical or cultural limitations?
- What (if any) are the growth opportunities which are available?
- How is the market segmented?
- Who are the customers (if they exist), and if not who will they be?
- Why are customers buying or why would they buy from your company?
- Are there any long-term purchase agreements?
- Is there any trend among customers toward integrating manufacture or provision of the product or service into their organisation?
- Does a substitute product exist, and if so, how effective/available/expensive it is?
5. Competitive Landscape
- Who are the major competitors?
- What is their unique advantage, and are they growing?
- How do they compare on key buying issues?
- What are their plans for the next 6-18 months and how will they react to you entering the market?
6. Sales and Marketing
- What are the pre-contract sales costs, and how long is the sales cycle?
- How much customising of orders is required/available?
- What are the upgrade obligations? Are they clearly defined?
- Is the product/service well documented?
- How much engineering support is required on installation and in operation?
- How is the sales/marketing team structured? What is its size? Cost? ROI?
- How are sales and marketing staff used? How are they selected and compensated?
- What are the channels of distribution, and how is advertising and promotional activity carried out?
- What is are the sales forecasts and associated justifications?
- How is the product priced, and what are the company’s credit policies?
7. Operations
- What and where are the company’s fixed assets and facilities?
- What is their condition? Is this a fair and independent valuation?
- What are the company’s required facilities and equipment needs?
- What is the basic manufacturing or delivery processes?
- How are procedures being modified to improve efficiency of these?
- What system is in place to assure the quality of the product or service?
- Who and what are the critical suppliers, contracts and raw materials required, and what is being done to ensure supply of these?
- What factors might cause a substantial delay in production?
- How much stock and inventory does the company hold, and how quickly will it become obsolete?
- Are there any contractual obligations lasting longer than 6 months
8. Financial Considerations
Finances always require expert scrutiny. Make sure you get copies of:
- Audited financial statements
- A complete breakdown of all ownership rights, and pro-rated security holdings issued by the company (including all classes of shares and options to buy these), and the associated value paid for each of these.
- A complete list of grants held, as well as grant opportunities.
- A complete list of all debtors, including ages, values and verified contact information.
- A complete list of all creditors, highlighting funds owed.
- Project finances, including cash flow.
- A complete list of all sources of funding and their use.
- A review of the account system used by the business.
- Complete details of insurance coverage.
- Complete tax liabilities and history.
9. Legal Matters
- Do you have a copy of the company’s Articles of Incorporation.
- Bylaws and Amendments.
- Minutes of Directors’ and Shareholders’ meetings.
- Subsidiary listing.
- Contractual agreements.
- Stock Option Plan.
- Does the company have any previous history of legal action (either as a defendant or a claimant)?
- Is the company’s product or service subject to any regulatory requirements?
- Environmental regulation/violations (waste discharge, RCRA, OSHA, EPA)?
- Does the business offer warranty and service guarantees? If so, what is the claim rate?
- Is their liability insurance in place, and is it sufficient?