Due diligence is an essential process to follow to reduce risk in a variety of transactions. Due diligence is the structured process of investigating and testing the true position of a business or asset.
Due diligence is typically used in business transactions, such as mergers and acquisitions, but can be applied in other contexts, such as when hiring a new employee or when making large purchases.
Due Diligence Processes
The due diligence process has several steps, including evaluating the goals of the project, analyzing business financials, inspecting documents, analyzing business plans and models, forming a final offering, assessing risks, and categorizing diligence efforts.
During the due diligence process, buyers carefully scrutinize every aspect of the target company or asset, from the business plan to real estate and cash flow. The back and forth between bidders asking questions and sellers responding is the most intense stage of the process.
Subject Matter Experts
Subject Matter Experts (SMEs) play an important role in due diligence. SMEs are sought by companies facing a specific challenge that goes beyond their scope of understanding, such as understanding customer preferences, conducting product surveys, and benchmarking studies.
SMEs provide meaningful guidance to research, due diligence, and information critical to achieving strategic business objectives. Compliance Quarter has acted as a subject matter expert in a number of transactions including in relation to regulatory compliance and the energy industry.
Due Diligence Checklist
A due diligence checklist is an important tool to map out the due diligence process. Each checklist should be drafted after a complete understanding of the objectives of the transaction and the context of the transaction. A comprehensive checklist helps to identify potential risks, liabilities, and obligations in the deal, allowing for well-informed decisions.
Below is a table of areas that can form the basis of a due diligence checklist
| Area | Considerations | Measures/Indicators |
| Financial | Revenue and profitability | Annual revenue, net income, gross margin, EBITDA, Return on assets |
| Capital structure | Debt-to-equity ratio, interest coverage ratio, cash on hand | |
| Operating costs | Operating expenses, cost of goods sold, SG&A expenses | |
| Investment history | Capital expenditures, return on invested capital | |
| Financial forecasting | Projected revenue and earnings, assumptions used in forecasting | |
| Legal | Contracts and agreements | Key customer and vendor contracts, employment agreements, lease agreements |
| Intellectual property | Patents, trademarks, copyrights | |
| Litigation and regulatory issues | Ongoing legal disputes, regulatory compliance, breaches | |
| Operations | Production capacity | Equipment and facility capacity, production efficiency, lead times |
| Supply chain | Key suppliers, inventory management, logistics | |
| Quality control | Quality assurance procedures, ISO certification | |
| Human resources | Employee headcount, turnover rate, benefits and compensation | |
| Market | Industry analysis | Market size, growth rate, key competitors, market trends, wider economic trends, market risks |
| Customer base | Customer demographics, customer loyalty, customer concentration | |
| Sales and marketing | Sales channels, marketing strategies, brand recognition | |
| Product/service offering | Product/service portfolio, pricing strategy, product/service differentiation | |
| IT | IT infrastructure | Hardware and software systems, data storage and security, backups and disaster recovery |
| IT support and maintenance | IT staff, IT service level agreements, IT budget | |
| IT developments and plans | IT projects in progress, IT development pipeline, IT road map | |
| Regulatory Compliance | Compliance and Licenses | Compliance with the laws and regulations, licences and permits |
| Audits and Inspections | Results of any audits and inspections, penalties and enforcement actions | |
| Risk Management | Risk management policies and procedures, insurance coverage | |
| HR | Employee Relations | Employee engagement, employee satisfaction, employee retention rate |
| Employee Development | Employee training and development programs, career development opportunities | |
| Compensation and Benefits | Salary, bonuses, benefits, retirement plans | |
| Recruitment and Hiring | Recruitment and hiring processes, diversity and inclusion policies |
If you would like to discuss a potential transaction or similar project, please contact us.
Citations and further reading:
1. https://legal-dictionary.thefreedictionary.com/diligence
2. https://dealroom.net/faq/due-diligence-process
4. https://legal.thomsonreuters.com/en/insights/articles/what-due-diligence-checklist-template
