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Due Diligence – how you discover the true value

Due diligence is the process by which you determine the true cost or value of a business transaction, whether it be buying, selling or merging companies, investing in a major project or entering a contract with a new supplier.

Business

By identifying the potential for value creation, you can put a price on the transaction. What you discover through due diligence has a significant impact when negotiating the terms of your transaction. However, it is not a “one size fits all” process. There are many types of due diligence and the elements you include will depend on your individual case.

Sell-side due diligence, also known as vendor due diligence, is commissioned by the vendor of a business at the beginning of the sale process. It is a comprehensive assessment of the business to be sold, including details of historical performance, track record and the achievability of future plans and projections.

Buy-side due diligence is commissioned by a potential buyer, with the aim of confirming the attractiveness of an investment. Its scope will depend in part on whether the vendor has provided sell-side due diligence, and in part on the nature of the transaction. Potential components include:

Legal due diligence: This addresses the legal structure of the business and its legal relations with third parties. It covers aspects such as contracts, loans, property, intellectual property rights, employment and pending litigation.

Financial due diligence: The purpose is to verify the business’s financial information and assess its underlying performance. It involves scrutinising earnings, assets and liabilities, cash flow, debts and financial management.

Commercial due diligence: This examines the industry status quo, trends and market environment. It assesses the company’s capabilities and the likelihood of it achieving its projections, in light of the competitive market. Financial and commercial due diligence are often grouped together under the umbrella of strategic due diligence, and distinguished from operational due diligence.

Operational due diligence: This comprises a comprehensive internal health check of a company, assessing the potential for value creation in the short term. The focus is on operational and internal data, rather than the strategic and commercial aspects of the business which feature in strategic due diligence. Areas for scrutiny include purchasing, marketing and sales, the manufacturing and supply chain, and administration such as finance, HR and IT. The aim is to explore the company’s efficiency; identify areas for short term improvement; and spot opportunities for coordinating processes, promoting shared services, outsourcing and offshoring so as to make savings through improved efficiencies. It is key to determining an accurate bidding price.

Information for due diligence is gathered from many sources: financial details from company reports giving historic figures, recent filings, mortgage data and details of County Court Judgments; director details from director reports, listing current and past directorships and disclosing a director’s connections with other companies; market data from market research and economic forecasts; and business news from trade titles and press searches. The process of collecting and interpreting information, and producing a comprehensive analysis of your proposed business transaction, can take several weeks. It is worth the wait, though, as proper due diligence can mean the difference between business failure and success.