One of the most essential steps toward purchasing an existing company is a due diligence audit, which provides an overview of the target company to be acquired. The potential acquirer will need to learn a significant amount of the company's history, its current state and its future projections. Here are the audit's most crucial elements.
Research the Seller
- Find out why the company is selling
- Analyze the business plan, company structure and its complexities
- Compare the seller's market position versus competitors
- Study other mergers or acquisitions within the same industry in recent years
- Examine barriers of entry and whether it's worth the risk to fill a market void
- Contact current managers to discuss reporting relationships and business roles
- Determine strong and weak sales regions
- Obtain an organizational legal chart to study subsidiaries, officers and investors
Employees and Benefits
The interested company will need a list of the key employees who are most responsible for operating the business. Studying the number of employees and the types of benefits will help determine company costs. It's best to compile separate lists that distinguish between top employees and the subordinate workforce. Be aware of workers who have close connections with customers to preserve loyal business.
A major consideration is whether or not the current business culture includes union representation. The potential acquirer will need to study union contracts to analyze the company's history and philosophy regarding pay scales, working conditions and guaranteed benefits. Health plans, pension plans and other benefits need to be studied thoroughly. This review will help determine the degree to which costs can be cut through outsourcing. Request a copy of the employee manual to get comprehensive information about existing worker policies.
A crucial component of any due diligence audit is a comprehensive analysis of the company's financial health in the form of statements of annual earnings, cash flows and balance sheet data. Pay close attention to year-over-year gross revenue and net income. Other key metrics are earnings per share, number of shares outstanding, company expenses and dividend payments to investors. A deeper understanding of the company's finances can be learned from banking information, forecasts, disclosures and public filings.
Make sure to have a firm understanding of how the business collects revenue and the total amount of backlog that has accumulated. Examine recent accounts receivable to be clear on overdue invoices, which along with recurring revenue will help shape earnings forecasts. Understand how the company sets its prices and how costs affect profits. By analyzing cost structure, investments, expenses and loans, the interested company will be able to further envision potential budget cuts to increase profit margins.
Other monumental financial factors are assets, liabilities, equity, valuation and taxes. These accounting elements will give a clear idea of the long-term financial health of the business. Determine if outstanding debt is manageable and if issues such as depreciation, lawsuits and unpaid taxes will affect the operation adversely going forward. Legal issues regarding contracts, licensing and regulations must be reviewed carefully.
- Study materials management such as supply chain logistics
- Determine if inventory systems are sufficient in terms of storage and tracking
- Identify transportation expenses that may affect costs of goods
- Review equipment systems, disaster recovery plans and the Information Technology team
- Evaluate the company's branding and marketing strategies
In conclusion, a due diligence audit is a gateway to the next step in acquiring a target company. It will eliminate future surprises and give the potetial acquirer the best indication possible if the venture is worth pursuing. Additionally, you will need to conduct a thorough investigation of board minutes, shareholder minutes, and audit committee minutes.