Due diligence is the process of gathering, analyzing and verifying information before making a decision. In private equity, due diligence is one of the most critical elements of the transaction process because it helps buyers to understand a business from top to bottom and evaluate whether to move forward with a merger, acquisition or exit.
At Blackford Capital, we pride ourselves on a rigorous deal sourcing process. We look at between 2,000 and 4,000 lower-middle market and middle market deals each year, evaluating each one against our disciplined investment criteria. Due diligence gives us the information and data we need to determine if a transaction is right for us.
We’ve honed our approach to due diligence over the course of 34 completed acquisitions since 2010 and have created a robust process that has helped us generate $650 million in transaction value in that same span.
Whether you‘re beginning the process of selling your company to a private equity firm or are simply looking for ways to improve your existing strategy, here are a few best practices that must be included in due diligence.
A Thorough Process
Due diligence should never be taken lightly. Entering the due diligence process without a strong strategy and structure will likely result in missed information and can cause repercussions for the entire transaction.
A good due diligence process should include individual responsibilities, task and project deadlines, documents that each side will require and a list of questions that you plan to ask. You should also be developing an internal meeting and reporting structure to make sure everyone is on the same page.
Perhaps the only thing more important than a thorough due diligence process is a team that follows that process. It’s critical that everyone understand their role in the process and commit to fulfilling their responsibilities accurately and on time.
Remember that due diligence can be a long process, requiring high levels of attention to detail to ensure everything is verified, tested and audited to ensure validity and accuracy. Developing a thorough process will help things move as smoothly as possible and allow you to focus on the information and data rather than dwelling on administrative details.
Open and Transparent Communications
Due diligence requires a culture of trust and honesty on all sides. A lack of open communication can lead to problems on both sides of the transaction, and in some cases result in misunderstandings that sink the deal altogether.
When beginning a due diligence process, start by establishing norms and expectations around communications. This should include what conversations will be held in person and which will be virtual, who will be responsible for scheduling meetings and sharing information and where information will be stored.
Throughout the process, there may be many difficult and intense conversations, with a lot of detailed information moving back and forth.
There are a lot of intangibles in the due diligence process. However, with robust communication and each side contributing equally to the dialogue, the transaction operates with much greater success for both parties.
While due diligence is typically focused on finances, many departments within a company can – and should – play a role in the process, contributing their insights and expertise.
For example, due diligence processes often fail to consider the people and cultures of the involved organizations, and how they would work together in a combined company. Although people and culture are not as easily quantifiable as other parts of the due diligence process, including an expert in human resources can help identify possible issues and red flags.
Buyers concerned about post-acquisition integration could also bring in a communications consultant to review and compare communication styles and structures or evaluate how digital and social properties align.
At Blackford, our team of six operating partners and more than 50 independent directors provide expertise in all aspects of corporate structure, allowing us to access insights at a level unmatched by comparable PE firms.
An Industry-specific Checklist
Whether you’re buying or selling, make sure your due diligence includes the following areas below.
For each of these areas, you will want to determine what documents you will require as well as what questions you will ask company leadership. When developing your due diligence document request and questionnaire, be as thorough as you can. It’s better to delete what you don’t need rather than miss a critical question during a transaction.
- Corporate Organization and Structure: articles of incorporation, bylaws, shareholder information, agreements
- Financial Information: financial statements, credit reports, analyst reports, financial projections, expenses, margins, and product line profitability
- Physical Assets: listing of fixed assets and locations, equipment sales, purchases and leases
- Real Estate: listing of locations by address, copies of leases/mortgages/deeds
- Intellectual Property: patents and patent applications, trademarks, consulting agreements
- Employees and Employee Benefits: list of employee salaries and bonuses, company handbooks, collective bargaining agreements, payroll information, retirement plan information
- Licenses and Permits: governmental licenses, permits or consents
- Environmental Issues: audits, permits and licenses, hazardous substance use
- Taxes: federal, state, local and foreign tax returns, audits or revenue agency reports, tax filings
- Material Contracts: loan agreements, contracts between the company and stakeholders, subsidiary, partnership or joint venture relationships
- Customer Information: supply and service agreements, schedule of largest customers, purchasing policies and procedures
- Litigation: pending, threatened, or completed litigation
- Insurance: claims history, copies of applicable insurance policies
- Professional Firms: Listing of all professional services firms used, including Legal, Accounting, Tax, Consulting, etc.
- Publicity: press releases and articles, documentation of website and URL ownership websites
- Digital: social media channels, brand visibility and reputation, affiliated URLs, competitive digital audit
Remember, you’ll want to be sure to add industry-specific categories to this list to ensure you’ve covered all your bases! Implementing these best practices will help make the due diligence process smooth and enable transactions to be completed successfully. Blackford Capital is always seeking to partner with exceptional manufacturing, industrial and distribution companies that fit our investment criteria.