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Due diligence is a critical part of any M&A deal. By thoroughly preparing for the M&A process and knowing what to expect during due diligence, including the questions you should be ready to answer, you’ll stand a much better chance of a successful and profitable transaction.

But what types of questions are typically asked during the due diligence process? Failing to appear organized and properly prepared for the process can create concerns for the buyer, potentially putting the deal and your business at risk.

Any due diligence process should begin with basic organizational questions about your company and its finances. Depending on your M&A partner, there may be various other types of questions asked as well.

This due diligence checklist will guide you through each step of the process, listing some of the most commonly asked questions during due diligence.

Due Diligence Checklist

Due diligence is a comprehensive evaluation of a business’s operations, finances, legal standing, and other relevant areas. To ensure a thorough assessment, this checklist of questions can help guide the process and ensure that no critical areas are overlooked.

1. Company information

This should be the first bullet in your due diligence checklist because this information will provide you with insights into the business’s decision-making processes, strategic direction, management style, priorities, labor relations, and potential issues.

• Who owns the company?
• What is the company’s organizational structure?
• Who are the company’s shareholders?
  • What percentage of the company does each shareholder own?
• What are the company’s articles of incorporation?
• Where is the company’s certificate of good standing from the state in which the business is registered?
• What are the company bylaws?
• Where are the company’s most recent annual reports and minutes from board meetings?
• Who is on the company’s senior management team, including job title, salary, and years in the position?
• What are the company’s employee benefits?
• Are the company’s employees unionized?
  • If so, what is their contract?

2. Finances

Obtaining a company credit report, as well as material related to a company’s tax and other financial statements, is crucial for conducting proper due diligence. This information sheds light on a business’s financial health, its ability to generate profits, and potential risks and liabilities that may impact future operations.

• Where are the company’s quarterly and annual financial statements from the past several years?
  • This includes the company’s balance sheets, accounts receivable, accounts payable, and income statements.
• Where are the company’s federal, state, local, and foreign tax returns from the past several years?
• How often are the company’s financial statements and tax returns audited?
• What are the company’s itemized business expenses?
• What is the company’s gross profit margin?
  • Is it increasing or decreasing?
• How much debt is the company carrying?
• What capital expenditures does the company plan to make in the near future?
• What are the company’s current financial models and forecasts for future business activity?
  • Does the business have adequate financial resources to continue operations?

3. Products and services

Your due diligence checklist should cover questions regarding information about products and services. Not only will it help you assess their status, but you’ll learn who their vendors and suppliers are. This will allow you to evaluate the competitiveness of the business. Additionally, identifying a business’s main competitors and what they offer is important in determining the future success of the business.

• What are the company’s current and future products and services?
  • How do these compare to those of the company’s competitors?
• Who are the company’s most important competitors, both now and in the future?
  • What are their strengths and weaknesses?
• What are the costs and profit margins of the company’s products and services?
• Who are the company’s current vendors and suppliers?

4. Customers

Examining a company’s customer base and business locations is important as it provides insights into the company’s market reach and potential areas for growth. This information can help identify any issues and opportunities or guide strategic decisions.

• In which locations (states and countries) does the company do business?
• What is the company’s customer base?
  • If a B2B company, who are the company’s most important customers?
• What are the company’s current and future marketing campaigns?

5. Technology assets

Information about technology assets is necessary for assessing a business’s potential to innovate and stay competitive in the market. By evaluating a business’s technology assets, investors can make informed decisions regarding their investment in the business.

• What software and hardware does the company use?
  • What are the currently active software licenses?
• How much is each IT asset utilized?
• How old is the company’s hardware?
• Does the company outsource any of its IT responsibilities?
• What is the company’s disaster recovery plan for data breaches or data loss?

6. IP assets

Intellectual property assets are another critical part of due diligence. Understanding who owns certain IP rights, as well as how IP is protected, will help you assess the legal risks associated with a business’s IP assets.

• What is the company’s intellectual property, and who owns this IP?
  • Does the company own any patents, copyrights, trademarks, or trade secrets?
• How does the company protect its IP?
• How much revenue does each IP asset generate?
• What potential legal liabilities does each IP asset pose to the business?

7. Physical assets

In order to gain a comprehensive understanding of a business, it’s essential to examine its physical assets, including any real estate holdings, inventory, and equipment. By gathering information about these aspects, a clearer picture of the company’s operations can be obtained.

• What are the company’s real estate assets?
  • Does the company have real estate deeds, leases, or mortgages?
• What inventory and equipment does the company have on hand?

8. Legal issues

Legal due diligence provides information about the company’s policies and procedures. This includes an examination of the company’s history of legal and regulatory compliance, as well as any related legal risks or liabilities.

• What are the laws and regulations that apply to the business and its industry?
  • Is the company subject to any environmental regulations?
• Does the company need any permits or licenses in order to run a business?
• What is the company’s past, current, and future litigation history?
  • Does the company have any injunctions or settlements as a result of this litigation?
• What are the company’s insurance policies?
  • This may include professional liability insurance, workers’ compensation insurance, vehicle insurance, commercial property insurance, key person life insurance, and intellectual property & patent insurance.
• Are there potential antitrust concerns that would arise as a result of the merger?

When you’re preparing to sell your business, going into due diligence with a clear idea of what you’re up against will greatly increase your odds of success. Making sure you have the answers to all of the questions in this due diligence checklist is a good place to start.

During the due diligence process, it is crucial to ensure the security and confidentiality of sensitive information. One way to achieve this is by utilizing a secure virtual data room  (aka virtual deal room). They offer a secure and controlled environment where buyers, sellers, and advisors can securely review, analyze, and exchange confidential documents.

In recent years, the world of private equity has moved from a niche topic in the financial industry into the mainstream. Despite the outsize attention that private equity has received, however, many people still aren’t certain about the ins and outs of the field, including terms like “capital calls.”

Capital calls are a highly useful tool in private equity, but one that should be used with caution and a good idea of the consequences. Read on to learn more about this important technique.

What Is a Capital Call?

A capital call, also known as a “draw down,” is the act of collecting funds from limited partners whenever the need arises. When an investor buys into a private equity fund, the firm makes an agreement with the investor that these funds will be available when the firm requests them. In turn, investors are able to hold onto their funds and keep them in a favorable investment account, such as a mutual fund or retirement account, so that the investment can continue to appreciate until the firm needs it.

Private equity firms typically issue capital calls when an investment deal has been reached and is nearing close. Investors have a predetermined amount of time, which is usually between a week and 10 days, to provide the funds. Once investors provide the funds they are repaid later on with capital contributions. 

When Should You Use a Capital Call?

Historically, capital calls have been frequently used by real estate funds. Because the firm may spend some time finding an attractive real estate investment before buying, it may not need access to investors’ funds right away.

However, more and more private equity funds are taking advantage of the tactic for a number of reasons. Capital calls provide increased flexibility and can be useful for attracting investors who want to benefit financially from that flexibility. Because the investment may be spread out over a period of months or even years, investors can maximize their return on investment while they wait for their funds to be requested.

In general, by giving you access to more funds on a short-term notice, capital calls improve your ability to deal with surprise changes and shifts in the market as well as investment projects that unexpectedly go over budget. You may also be requested to perform a capital call by banks or other institutions in order to secure financial agreements.

What Are the Dangers of Capital Calls?

Capital calls are not without their risks, however. Because you don’t actually have access to the funds until they arrive in your bank account, you may be unable to obtain all of the funds that you were initially promised from investors, which can lead to a default. Private equity firms use a number of strategies to discourage defaults, including sanctions against the investor and withholding future income distributions.

In addition, if you issue a capital call too early, without having a deal in place, you may receive too many funds. You should only use capital calls to fund investments on which a deal has been reached, not on speculative deals or on operational costs.

Finally, relying too much on capital calls can make your fund appear too unstable for many investors. This is because firms that frequently use capital calls typically have fewer liquid assets available. Secure virtual data rooms can provide a secure environment for private equity firms to communicate with investors and share confidential documents. By leveraging a data room, firms can ensure the confidentiality and integrity of sensitive information during the capital call process.

As other economic factors continue to stabilize after devastating drops during the early aughts, trends in private equity investment continue to trend up slowly over time. Venture capital investments, for example, rose from around $15.59 billion in the United States in 2002 to approximately $71.94 billion in 2017. Typically, these are investments in startups and young, innovative brands, but larger target companies also continue to see investor interest. In these cases, it’s more likely specialty investors with the right resources are interested in providing either growth capital or buyout capital.

Growth Capital v. Buyout Capital

At a basic level, the differences between growth capital and buyout capital are obvious in the names. Growth capital is typically invested to foster growth – possibly out of a stagnant or troubled financial situation – for the target company. The investors reap rewards via returns from guaranteed dividends, stocks, or the future sale of shares once the company is performing better.

Buyout capital, on the other hand, typically involves a controlled takeover. The investors, or the entities backed by the private equity firm, acquire ownership by buying controlling interest in the organization. Typically, the use of buyout capital is followed by reorganization that positions the target company to be more profitable. Restructuring might include cost-cutting and process improvement or dismantling and selling certain parts of the organization considered to be loss-makers. The goal for investors is usually to flip the shares for a future profit once the business goes public in an IPO or sees substantially improved performance in the market.

Which Is the Better Option?

On the surface, growth capital might seem like the best option for the target company and the riskiest venture for the private equity investor. In reality, both types of capital come with risks and rewards for either side.

Growth capital is good for a target company that is simply floundering and needs help to charge the market. It lets management and owners retain a lot of control, and it helps them position their brand for future success. For the investor, growth capital in a brand with strong potential can be very rewarding, but since control remains with others, most private equity investors minimize the amount of their portfolio tied up in growth capital at any given time.

Buyout capital can still be good for a brand, although current owners and leadership must relinquish control or even affiliation with the target company through the process. The exact nature of the transfer varies with each acquisition. Ultimately, buyout capital is a good option when a company has reached a point where major changes are required to move forward; buyout capital can save a brand and even many of the jobs associated with it. For the investor, buyouts can represent substantial returns or equally substantial losses, which means equity firms and investors are unlikely to enter into many such endeavors at one time.

Understanding the various types of investment approaches taken by private equity firms is just one step businesses can take if they want to attract those investors. Target companies may need to do some internal house cleaning and other work before they can partner with the right private equity investor, especially when turning to growth capital as a way to bolster future success.

Private equity investments involve extensive due diligence, requiring the sharing of financial statements, legal contracts, intellectual property documents, and other confidential information. No matter the option you choose, secure data rooms can dramatically facilitate private equity investments by providing a secure and efficient platform for the exchange of sensitive information between investors and target companies.  

Secure data rooms provide a centralized repository where all these documents can be securely uploaded, organized, and shared with authorized parties. This ensures that sensitive information remains protected from unauthorized access or data breaches.

Merging with another company is a great business accomplishment and a momentous event, which means that it’s highly important for you to do it the correct way. There are countless types of mergers–horizontal, vertical, conglomerate, and concentric, just to name a few–so you need to be familiar with the appropriate terms and concepts well in advance.

This article will discuss three different types of mergers: forward, forward triangular and reverse triangular. By learning the key differences and advantages of each one, you’ll be able to decide for yourself which option is right for your organization.

Forward Merger

Forward mergers, also known as direct mergers, are those in which the target company merges directly into the buyer. The target company ceases to exist, and the two companies continue to operate as a single entity under the buyer’s name and structure. In addition, the buyer assumes all of the target company’s assets and liabilities.

Pros and Cons of Forward Mergers

Forward mergers are sometimes the most preferable choice because they are a direct action between two companies. This makes it easier to integrate the two companies during and after the merger, and preserve the buyer’s business continuity.

However, because the buyer directly assumes the target company’s liabilities, it does not have any legal protection against these concerns. Forward mergers may also require the buyer’s shareholders to approve the transaction, making it more time-consuming and complex.

Forward Triangular Merger

As the name suggests, triangular mergers are those that involve three companies: the buyer, the target company and a third organization that is a subsidiary or shell company. In a forward triangular merger, the target company is merged into the buyer’s subsidiary, which also assumes the target company’s assets and liabilities.

Pros and Cons of Forward Triangular Mergers

Using a subsidiary to perform the merger gives the buyer more protection against problems with the target company’s liabilities. In addition, performing a forward triangular merger gives the buyer much more flexibility in terms of purchasing the target company’s stock than a reverse triangular merger. Half of the total consideration that the buyer uses to pay the target company’s shareholders can be in cash or other non-stock options.

However, because the target company ceases to exist, performing a forward triangular merger can be problematic in terms of business continuity. The target company’s contracts, licenses and authorizations may all have to be reassessed.

Reverse Triangular Merger

A reverse triangular merger is identical to a forward triangular merger except in terms of the surviving company. In a reverse triangular merger, the buyer’s subsidiary is merged into the target company, which continues operations as a subsidiary of the buyer. Therefore, whether a triangular merger is performed in forward or reverse, the end result is the same: the target company becomes a subsidiary of the buyer.

Pros and Cons of Reverse Triangular Mergers

Like the forward triangular merger, reverse triangular mergers can be advantageous by isolating the target company’s liabilities to a subsidiary of the buyer. In addition, because the target company survives the merger, it can easily continue operations without having to sign new contracts or obtain new licenses and authorizations.

However, in order to perform a reverse triangular merger tax-free, the buyer must use company stock to acquire at least 80 percent of the target company’s stock. This makes the transaction less flexible in terms of payment options.

Secure Data Rooms in M&A Transactions

In today’s digital landscape, the secure exchange of information is a paramount concern in M&A transactions. No matter the type of merger you are involved in, confidentiality and data security are vital to ensure the success and integrity of the merger process. This requires a secure environment for sharing sensitive information with authorized parties involved in the deal.

A virtual data room, also known as a virtual deal room, serves as a centralized hub for storing and accessing critical documents and data. It offers a range of features designed to protect the confidentiality and privacy of information, reducing the risk of unauthorized access or data breaches.

Deal room software streamlines document management in M&A transactions, enabling seamless collaboration, version control, and document tracking. It simplifies the review and analysis of crucial financial, legal, and operational documents for both the acquiring and target companies. This efficient process plays a vital role in evaluating the necessary metrics and making well-informed decisions throughout the merger.