Due diligence is an analysis of a business’ financial, legal, and operational functions. It’s a process designed to verify that a business owner is correctly portraying their business, and uncover any potential risks associated with the business.
Let’s break down the key steps of good due diligence.
Start with the LOI & A Good Team
The due diligence process should be clearly outlined in the Letter of Intent (LOI). This allows both parties to agree on the timespan, required documentation, and extent of the due diligence. Hiring a lawyer and an accountant will ensure that you have the skills necessary to draft the LOI, assess the company’s financial and legal situation, and avoid any oversights.
The process typically lasts 30 to 90 days.
3 Primary Components of Due Diligence
There are three main components of due diligence: financial, legal, and commercial. We’ll break down each component and provide a checklist, as outlined by the BDC (Business Development Bank of Canada).
Financial Due Diligence
Financial due diligence helps confirm the profitability of the company. Here are the key financial documents the buyer may request from the seller:
- Accountant-prepared year-end financial statements for at least the past three to five years
- Interim year-to-date statements and statements for the comparable period from the prior year
- Trial balances
- Financial forecasts
- Tax returns
- Bank statements
- Budgets
Legal Due Diligence
Legal due diligence assesses the legal damage and vulnerabilities of the business. Here are some key areas a buyer will want to inquire about:
- Ongoing, pending or threatened litigation
- Past lawsuits that may have affected the business
- Employment contracts
- Leases
- Customer and supplier agreements and warranties
- Laws and regulations affecting the company
- Licences and permits
- Real estate and intellectual property issues
- Corporate documents (e.g., certificates of incorporation, company bylaws, shareholder agreements)
Commercial Due Diligence
Commercial due diligence is an analysis of the assets, employees, and other key features of the business. During commercial due diligence, buyers may evaluate:
- The business model and strategic plan
- The market landscape and important trends affecting the company, such as: technological change, regulations, customer trends and industry disruption
- Key customers, suppliers, and employees
- Significant risks, such as customer or supplier concentration
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* Please note that the information in this article is not intended as legal advice, but rather as a general overview on the subject. If you are seeking legal advice, please consult with a lawyer.
