Acquisition due diligence is a key step of the acquisition lifecycle — it gives you a clear picture of the company being acquired and allows you to negotiate from an informed and confident position.
In this process, a due diligence checklist is one of your main tools for success. It shows you which areas to examine closely and helps steer you through the large amounts of paperwork involved.
What is acquisition due diligence?
Acquisition due diligence means examining and researching a business you intend to acquire. Put simply, acquisition due diligence is nothing more than doing your homework to make sure you acquire real value — and don’t overpay.
Whether you’re buying an existing company as your first business venture or to expand or complement your company, due diligence is a fundamental process to ensure you understand the risks and potential associated with the purchase.
Acquisition due diligence entails conducting a general examination of the several components of the target company, including operational structure, finances, existing or potential legal issues, industry placement and prospects, business size and maximum valuation, and other aspects of importance to any business.
Definition of due diligence checklist
An acquisition due diligence checklist is a comprehensive list of all the documentation items to be considered by the side looking to acquire a company, with a view to determining the potential risks and benefits of the acquisition.
A due diligence checklist will usually include a broad range of documents, such as:
- Financial statements and other financial documents
- Contracts, environmental audits
- Intellectual property titles
- General corporate records
- Corporate structure documents
- Other important business information (see more below)
While the specific documents in a due diligence checklist may vary widely according to the kind of transaction (and the type of business) in question, its overall purpose remains the same: to ensure the buying side has a clear understanding of the target company’s prospects and liabilities and is able to identify and address potential issues before concluding the transaction.
How can a data room help with acquisition due diligence
Business technology has moved in rapid strides over the past decade, with the virtual data room being one of its most notable developments.
Essentially a highly secure, cloud-based space for data storage and sharing, an online data room allows you to conduct high-stakes, document-intensive, sensitive transactions such as acquisition due diligence with greater ease and security.
Data rooms are developed along several dimensions, including:
- Data room security
- Data privacy and confidentiality
- Availability and ease of access
Let’s take a look at how an online data room works along each of these dimensions, helping you set up a due diligence checklist and conduct due diligence with competence and confidence.
Data room security
A combination of bank-grade cryptography, high-level authentication protocols, and multiple access restrictions make data rooms a safe environment for confidential company data.
Among many other security functions, data rooms help deter account hacking and impersonation by requiring mandatory two-step verification.
When logging in from a new device, a user is required to confirm their identity with a one-time password (OTP) sent to their email or phone. Even if a user password is hacked, their account will still be safe.
Additionally, advanced data rooms offer time-based access restriction to a data room or restriction of access from a certain IP address. These features serve as an extra layer of security during authentication.
Data privacy and confidentiality
Keep your data safe with a slew of advanced features such as multiple-level access controls, dynamic watermarking, and remote file control. Most data rooms also provide a complete audit trail, allowing admins to gauge user interaction with content hosted on the cloud.
A key data privacy feature is access control: you can assign users different levels of access that will determine how much of the data room they have access to. This helps you prevent leaks and keep your information accounted for.
Availability and ease of access
Data rooms allow companies to share all of the documentation necessary for due diligence in a single, centralized environment. Data room users can easily analyze how much storage is taken, what interactions with the documents are happening, and over what period of time. This gives data room users control and a birds-eye-view of the projects.
Among many other useful functionalities, many data rooms also provide custom checklist templates as a starting point for your due diligence process.
What to include in your checklist
Your due diligence acquisition checklist should encompass all of the key axes along which a company functions. This means going over the main documents for all of the following areas:
- Finances. Here you’ll be looking at financial statements, tax records, cash flow projections, accounts receivable, unaudited financial statements, foreign investment, and other records to evaluate the company’s financial health and future prospects.
- Legal documents. For your due diligence checklist, go over things like material contracts, licenses, permits, patents, trademarks and other agreements related to the company. Your goal should be to ensure the company has clear ownership of its assets and is in compliance with laws and regulations.
- Operations. Anything pertaining to the company’s supply chain, production processes, inventory management, and technology infrastructure are among the areas of attention in Operations.
- Customers and suppliers. Review the company’s supply relationship management (SRM) practices and supplier profiles, if available; do the same for prominent customers. This will help you get a clear grasp of things like customer loyalty and potential for growth.
- Human resources. Look into key employees — their experience, qualifications, and workers compensation packages are all important elements to consider.
- Management. Assess the company’s leadership. How important is the CEO/will they be retaining their role after the acquisition? Look into other key leadership figures and their roles in the company management.
- Marketing and sales. Get a good overview of the company’s marketing and sales strategies, customer acquisition channels, and overall marketing risks and positioning.
- Intellectual property. Assess the target company’s technology and intellectual property portfolio, including patents, trademarks, trade secrets, copyrights, etc.
- Regulatory compliance. Is the company in compliance with governmental regulations? Are there any government audits, antitrust and regulatory issues, or any other governmental proceedings active?
- Risks and liabilities. To assess potential risks and liabilities in the acquisition, look at any pending litigation, environmental liabilities, and disputes related to employment agreements or employee benefits.
What documents should you include in an acquisition due diligence checklist?
Let’s look in a bit more detail at the different categories and the types of documents you should include in your due diligence checklist.
1. Financial information
A financial due diligence checklist is aimed at giving you a good grasp of the company’s financials, including its recent history, current standing, and future prospects. Financial due diligence should typically include:
- Audited financial statements for the past three to five years, including balance sheets, income statements, and cash flow statements.
- Management accounts and internal financial reports, among which budgets, forecasts, variance analyses, and the like.
- Tax returns and supporting documents (also for the past three to five years), including federal, state, and local tax filings.
- Capitalization table and related documents (including stock option plans, warrants, and convertible securities).
- Schedule of outstanding debt featuring all bank loans, any lines of credit, notes payable, and other forms of debt that may apply.
- Schedule of accounts receivable and accounts payable, including aging reports for the past 3-5 years and payment histories.
- Insurance policies and related documents, including general liability, property, and product liability insurance.
- Fixed and variable expenses in the different areas of the company.
- Contingent liabilities and any documentation pertaining to them.
- Real estate leases and related documents, including rent rolls and occupancy reports.
- Banking documents, including deposit account statements, bank reconciliations, and loan agreements.
- Inventory reports and related documents, including inventory counts and valuations.
- Fixed asset schedules and related documents, including depreciation schedules and capital expenditure reports.
- Foreign subsidiary financial statements, if applicable.
- Due diligence reports prepared by previous potential buyers, if available.
- Customer and supplier information, including top customers and suppliers, concentration risk, and credit terms.
- Cash management documents, including bank account reconciliations, cash forecasts, and cash flow projections.
2. Legal documentation
Material contracts make up the bulk of the contractual obligations section for your due diligence checklist. Your team can leverage your legal documentation checklist during the due diligence process to identify potential litigation risks after the acquisition.
- Customer contracts, such as service agreements, purchase orders, supply contracts, and other agreements of the same nature.
- Supplier contracts, such as purchase agreements and orders, service agreements, and supply contracts.
- Contracts with employees, officers, directors, and shareholders, covering employment, non-compete, and confidentiality agreements.
- Leases, rental agreements, and sale and leaseback agreements for real estate, equipment, and other assets.
- Any indemnification agreements.
- Transfer pricing agreements.
- Financing agreements, among which loans, credit agreements, and security agreements.
- Joint venture, partnership, and other strategic alliance agreements.
- Distribution contracts, such as dealer, distributor, and sales representative agreements.
- Licensing agreements, including advertising agreements, intellectual property licenses, and software licenses.
- Marketing and advertising contracts, including agreements with advertising agencies, media outlets, and marketing partners.
- Outsourcing agreements related to service providers and others.
- Agreements relating to production and manufacturing contracts, including those with third-party manufacturers and suppliers, and company’s purchasing policies.
- Comprehensive disclosure schedule addressing all of the main exceptions to the representations and warranty claims provided by the target company.
Operations include technology, physical assets, and supply chain issues. Look into:
For some companies, physical assets can make up a large part of its current value, and as such should be included in your due diligence checklist, including:
- Equipment inventory with make, model, and serial numbers of equipment owned or leased.
- List of major equipment acquired over the past three to five years.
- Other main assets and their locations
Just as with a company’s physical assets, your checklist should encompass all of the relevant real estate documentation of the target company. Things like:
- A schedule of all owned and leased real estate, including property descriptions, addresses, and lease agreements.
- Records of property ownership (deeds, titles, surveys, and easements)
- Building inspection reports, including environmental, structural, and code compliance assessments.
Product and service lines
Part of understanding the company’s overall standing in the market, this section will require you to go over documents such as:
- Product or service descriptions, including specifications, features, and benefits.
- Documentation for the development and design processes (roadmaps, design drawings, and prototypes, among others.)
- Customer feedback and reviews (this can include surveys, ratings, and testimonials.)
- Sales and marketing materials, including brochures, presentations, and case studies.
- Intellectual property related to the products or services (also covered in the intellectual property section above)
- Product or service quality control documentation, such as certifications and regulatory compliance records.
- Performance data for products or services.
4. Customer and supplier information
A key area to include in your due diligence process is the company’s customer and supplier info. This will give you a better understanding of important business relationships that already exist and that should be given extra attention in future.
- A list of the company’s top customers and suppliers — this should include things like contact information, payment terms, and contract details.
- Contracts and agreements with key customers and suppliers, including franchise agreements, consulting agreements, and service level agreements.
- Customer and supplier performance data, including customer satisfaction ratings, on-time delivery rates, and supplier quality metrics.
- Customer and supplier creditworthiness, including credit reports and statements.
- Sales and purchase order history, including sales trends, order volumes, and seasonality.
5. Human resources
To get a good grasp of the company’s human element, including compensation standards, main leadership roles, and overall company culture, look into:
- Employee contracts (including non-compete and confidentiality agreements)
- Handbooks, policies, and procedures for company employees and contractors
- Payroll records and tax filings
- Employee benefit plans (such as healthcare, 401k, retirement, bonuses, etc.)
- History of worker’s compensation insurance policies and claims
- Organizational charts and job descriptions
- Performance management and evaluation records
It’s also a good idea to include a schedule of all relevant professionals engaged by the company over the last three to five years — law firms, auditors, accountants, business consultants, and similar outside contractors. Put together, this will give you a better understanding of how the company operates at a human and “job-description” level.
Management due diligence is all about understanding what drives the company forward in its day-to-day dealings — management roles, organizational structures, operational planning, and so on. For that, you’ll want to look at:
- Organizational chart. One of the key organizational documents of a company, this outlines the organizational structure of the company, as well as the roles and duties of its management team.
- Key management positions. Look at the makeup of the board of directors and at the resumes and biographies of key executives such as the company CEO and CFO.
- Minutes of board meetings. Board meeting minutes are important as a history of the decisions taken by the company’s board of directors, including major transactions or changes to the company’s structure and bylaws.
- Controls and policies: Include internal controls, and risk management policies and procedures that may be in place.
- Articles of association/bylaws. These are the company’s internal control procedures and rules governing operations and management; they provide important insights into the company culture and internal functionings.
- Stock ledger. A stock ledger records the names of the shareholders and number of shares owned, and is a way to keep track of investors and get a profile of who’s bought into the company.
7. Marketing and sales
This key section of your due diligence will help you understand the company’s commercial procedures and history, as well as how it puts itself out before the world and is generally perceived. Look to include things like:
- Marketing and advertising materials
- Sales performance data (revenue, sales growth over time, growth compared to competition, etc.)
- Sales pipelines and forecasts
- Pricing policies, discount structures, bulk sales, and other similar data
- Market research reports and analyses of the competition
- E-commerce analytics data, if applicable
Articles and publicity
For this section you should simply aim to include a list of news pieces, articles, and other publicity about the company over the past five to three years. Having a list of publicity items will help your team get a quick grasp over how the company’s reputation and public perception — an intangible, but certainly not immaterial aspect of a company’s worth.
8. Intellectual property
Intellectual property is anything from trade secrets and patents to copyright and trademarks, and can be a key value driver for some companies, especially in industries such as technology and pharmacy. Relevant documentation in the diligence checklist provided can include:
- Patents/patent applications, including documentation of ownership and any ongoing litigation.
- Trademarks and trade names (including trade names abroad)
- A list of copyrights
- Software, including licenses, development agreements, and documentation.
- Domain names and website content
- Customer lists and databases (if relevant, include privacy policies and data protection compliance documentation).
9. Regulatory compliance
For this section, you’ll be looking at internal documents that reveal how the company operates, as well as documentation from third parties that proves the company’s good standing — i.e., that its business is conducted in a legal and legitimate manner.
Here you can include documents such as:
- Certificate of incorporation/formation. The certificate of incorporation confirms the company is legally registered and entitled to conduct business according to governmental regulations.
- Shareholders agreements. If applicable, these will give you an overview of the company shareholder’s rights; agreements can include provisions relating to the transfer of shares, company management, or other matters.
- Business licenses and permits. Federal, state, and other permits and licenses that prove the company is operating legally within its industry and jurisdiction.
- Good standing certificate. This document confirms a company’s good standing before the relevant authorities; it proves the company has met legal obligations (such as filing annual reports, paying taxes, paying other fees, etc.)
- Certificate of incumbency. A list of all current officers and directors of the company confirming they are authorized to act on its behalf.
Another key step in due diligence is having your legal team or hired law firm go over the tax info of the target company — this will give you confidence in the company’s good standing and can potentially stave off some nasty surprises in the future.
Tax-related info includes a wide range of documentation:
- Federal, state, and local tax returns filed in the past five years, covering income tax, sales tax, and property tax.
- Records of any tax audits or disputes with local taxing authority (including notices of deficiency, settlement agreements, and appeals.)
- Any tax-related penalties or fines imposed on the company.
- State and local tax registrations, including sales tax, payroll tax, and other tax registrations.
- Historical income tax liabilities.
- Any tax exemptions or incentives, such as tax credits or abatements.
- Transfer pricing policies and documentation for cross-border transactions.
- Tax settlement documents, if any.
- Documentation for inter-company transactions and transfer pricing agreements.
- Tax provisions, including deferred taxes, valuation allowances, and tax contingencies.
- Any tax-sharing agreements that the company may have entered into with other entities.
- The documentation of any tax planning strategies or opinions that the company has adopted.
- The company’s tax reserves and any other tax-related liabilities.
- Any tax-related insurance policies or coverage that the company holds.
Environmental regulations and litigation can create major hindrances to business, meaning this is one of the areas of due diligence you cannot afford to overlook. Your environmental due diligence checklist should include:
- Environmental site assessments (including Phase I and II and other environmental reports or audits).
- Permits, licenses, and registrations required for the company to operate. This may include air and water discharge permits, waste management permits, and hazardous materials permits, among others.
- Records of any past or ongoing environmental incidents as well as environmental violations, fines, or penalties imposed on the company by regulatory authorities.
- Records of compliance with environmental laws and regulations, including waste disposal and emissions standards.
- Hazardous materials handling and disposal policies and procedures.
- Safety data sheets and chemical inventories.
- Information on contaminated sites owned or leased by the company, if applicable, including remediation plans and ongoing monitoring activities.
- Records of past or ongoing environmental litigation.
- Environmental insurance policy records, including pollution liability insurance.
- Other documentation related to the company’s practices in the environmental sphere, including sustainability reports or policies.
10. Risks and liabilities
Risks and liabilities can include anything from the areas mentioned above. Things like:
- Environmental aspects: lack of environmental compliance, exposure to contamination or hazardous substances.
- Market issues: looming market crashes or competition.
- Innovation problems: lagging behind competitors in implementing key technology (such as AI).
- Financial hurdles: accumulated debt, failure to attract investment, etc.
- Legal challenges: intellectual property issues, litigation, tax problems.
Litigation, in particular, can be a serious headache and should not be overlooked in your due diligence checklist. Completing it, make sure to go over the following items, in addition to those mentioned above:
- Regulatory proceedings involving the target company or key employees.
- Active or threatened governmental proceedings against the company.
- Threatened or pending lawsuits.
- Material litigation.
What are due diligence documents?
Due diligence documents are all the materials you need to analyze before acquiring a company or product. Due diligence documents vary according to the nature of the acquisition and the target company, but will typically include financial, legal, sales, and human resources documents.
How are due diligence checklists used?
Due diligence checklists serve as a quick walk-through of all the main areas to be analyzed during due diligence. Besides helping your due diligence team save time and steering the due diligence process, they can serve as a way to structure your online data room for due diligence.
Why is due diligence so important?
Due diligence is the process of analyzing a company before closing a deal, and such is a key step in any company acquisition or merger. Proper due diligence can help identify opportunities, reveal risks and liabilities, and overall provide a clearer picture of the pros and cons in an M&A deal.
Who conducts due diligence?
As a rule, the acquiring company will put together a team tasked with conducting due diligence. The team will typically include legal, finance, and HR experts, as well as the main company dealmakers and, sometimes, external auditors or consultants.
What is a disclosure schedule in mergers and acquisitions?
A disclosure schedule in mergers and acquisitions is a document that typically accompanies the purchase agreement and includes a list of all the exceptions to the representations and warranties made by the seller. It’s a key document in mergers and acquisitions, as it helps identify potential risks or liabilities in the transaction.