Due Diligence: Audit Process to Secure Business Acquisitions

Due Diligence: Verification Process to Secure Business Acquisitions

Due diligence is an indispensable part of every business acquisition. This comprehensive verification process is designed to analyze all relevant information about a target company and identify potential risks or opportunities. For buyers, due diligence is crucial to making an informed purchase decision and validating the purchase price. For sellers, it is equally important to professionally prepare the sales process and build trust with potential buyers.

In this article, we take a closer look at the various types of due diligence, the typical risks that may arise during the process, and the steps sellers can take to optimally prepare for this essential verification process.

Types of Due Diligence: A Holistic Review Approach

Due diligence encompasses several areas of examination, each with specific focal points. Depending on the industry, company size, and transaction objectives, these reviews may vary in intensity. The most important types include financial, legal, operational, and IT due diligence.

Financial Due Diligence: Examining the Economic Foundation

Financial due diligence aims to assess the company’s economic stability and profitability.

Review of Financial Statements and Balance Sheets: A detailed analysis of the last 3-5 years’ financial statements provides insights into the company’s financial position, profitability, and development. Particular attention is paid to items such as liabilities, provisions, and hidden reserves.
Cash Flow Analyses: Cash flow reveals the company’s actual liquidity. Payment flows are analyzed to ensure the company can cover its ongoing costs and finance future investments.

Legal Due Diligence: Reviewing Contracts and Rights

Legal due diligence focuses on the company’s legal security and uncovers potential liability risks.

Articles of Association and Corporate Bylaws: Buyers examine whether the corporate structure is legally sound and if the bylaws comply with applicable laws. Ambiguous or outdated clauses can lead to conflicts later on.
Licenses and Patent Rights: Does the company own protected trademarks, patents, or licenses? Reviewing these rights is especially critical in technology- or product-oriented companies, as the company’s value often heavily depends on these intangible assets.

Operational Due Diligence: Efficiency and Risks in Business Operations

Operational due diligence investigates the company’s workflows and structures to identify weaknesses or dependencies.

Supplier and Customer Structure: Is there an excessive dependence on individual customers or suppliers? Such dependencies can pose significant risks, as losing a key business partner could substantially impact revenue.
Production Processes and Cost Structures: Inefficient processes or high fixed costs can jeopardize the company’s competitiveness. Analyzing these areas helps buyers uncover hidden problems and identify potential savings.

IT Due Diligence: Focus on Technological Infrastructure

IT due diligence is gaining increasing importance as IT infrastructure plays a central role for many companies.

Software Licenses, Systems, and Databases: Buyers verify whether the software used is legally licensed and whether IT systems are scalable and future-proof. Outdated or unlicensed software can cause significant issues.
IT Security and Data Privacy Compliance: Compliance with the General Data Protection Regulation (GDPR) is a key criterion. Security gaps or violations of data protection regulations can cause not only financial but also reputational damage.

Checklists for Sellers: Essential Documents and Data

For sellers, facilitating the verification process through thorough preparation is crucial. Structured documentation of all relevant materials is indispensable. The following items should be on a seller’s checklist:

List of All Relevant Contracts: This includes customer and supplier contracts, employment agreements, lease contracts, as well as credit and leasing agreements. All documents should be complete and up to date.
Financial Records from the Last 3-5 Years: This includes profit and loss statements, annual financial statements, tax assessments, and accounting records. These documents form the basis for financial due diligence.
IP Registrations: Sellers should ensure that all trademarks, patents, and other intellectual property rights are registered and valid. This is especially important for companies that heavily rely on intellectual property.

Common Risks in Due Diligence

The goal of due diligence is to uncover risks that could reduce the transaction value or jeopardize the purchase. Typical issues that may arise during the review include:

Incomplete Contracts or Missing Approvals: Ambiguous contract clauses, expired permits, or undocumented agreements can weaken the company’s legal framework and pose potential liability risks.
Hidden Debts or Liability Cases: Undisclosed liabilities or ongoing legal disputes can significantly diminish the company’s value. Buyers therefore place great importance on transparent disclosure of all financial obligations.
Undocumented Processes or Dependencies: If workflows are not documented, it can be difficult for buyers to seamlessly take over the company. Similarly, dependencies on certain individuals or suppliers can pose risks.

Preparation: How Sellers Can Get Their Company Ready for Due Diligence

Thorough preparation of the company for due diligence builds trust with buyers and increases the chances of a successful sale. This includes:

Conducting Internal Pre-Audits: Sellers should perform an internal review to identify potential weaknesses or risks early on. External consultants can assist in managing the process professionally.
Standardizing and Digitizing Documentation: All relevant documents should be available in a consistent format and ideally in digital form. This not only facilitates the review but also leaves a professional impression.
Setting Up a Data Room: A virtual data room provides buyers with centralized and secure access to all necessary documents. This enables an efficient and structured review and reduces administrative effort for the seller.

Due diligence is an indispensable step in the sale of a company and requires thorough preparation from both buyers and sellers. While buyers aim to minimize risks and verify the investment’s value, sellers can strengthen trust with potential buyers and accelerate the sales process through transparent and professional documentation preparation.

Due Diligence