The Intensity of Acquisition Due Diligence

The due diligence phase of an acquisition is an incredibly intense and stressful period for the selling company. It is a forensic examination of every aspect of the business, designed to verify the buyer's assumptions and uncover any potential risks or liabilities. The buyer's mission is to find any "skeletons in the closet" that could jeopardize the deal or lower the valuation.

Key Areas of Scrutiny:

1. Accounting, Financial, and Tax

This is the most critical area and the one most often used to challenge the valuation.

• Business Performance: Historical financial records (3-5 years), performance against budget, quality of earnings reports.
• Future Growth: Profit trends, accuracy of financial forecasts, and working capital requirements.
• Taxes: Historical tax returns and compliance with all local, state, and federal regulations.
• Accuracy: Audited financial statements, disclosure of all debts and liabilities, and justification for capital expenditures.

2. Legal

The buyer needs to be assured that the company is "squeaky clean" from a legal perspective.

• Claims and Litigations: A complete record of all pending or past legal disputes.
• Regulatory Issues: Compliance with any industry-specific governing bodies (e.g., FDA, FTC) and any past or present antitrust issues.
• Environmental Issues: Disclosure of any ecological liabilities, especially for companies with physical properties.

3. Intellectual Property (IP)

The buyer must verify the ownership and security of the company's core technology.

• Properties: A full accounting of all patents, trademarks, copyrights, and third-party software licenses.
• Security: Proof of measures taken to protect trade secrets and confidential information.
• Legal: Disclosure of any ongoing IP disputes or infringements.

4. Team and Employees

The buyer is acquiring a team and needs to understand its structure and stability.

• Organizational Structure: A clear overview of the company structure and background on key employees.
• Compensation and Incentives: A summary of all compensation, benefits, and severance costs associated with the acquisition.
• Labor Issues: Disclosure of any past or present labor disputes.

5. Sales and Marketing

The buyer is acquiring a customer base and needs to understand how it was built and maintained.

• Customers: Analysis of the target customer, loyalty and satisfaction metrics, and customer concentration risk.
• Sales and Revenue: Seasonality, revenue generated by top customers, and sales team incentive structures.
• Marketing: In-house vs. agency structure, market analysis, and brand alignment with the buyer.

Due diligence is a grueling but necessary step. A founder's ability to prepare for these questions and respond quickly and thoroughly is critical for maintaining the buyer's confidence and getting the deal across the finish line.