In the business world, the phrase “Don’t accept a deal until you’ve done your due diligence” is often repeated. It’s true: The consequences of not performing thorough due diligence on the company and valuation could be catastrophic both financially as well as reputationally.
Due diligence for a company involves reviewing all the information a buyer will need to make an informed decision about whether or not to acquire an enterprise. Due diligence helps to identify potential risks and provides the basis for capturing value over the long-term.
Financial due diligence involves examining the accuracy of the income statements, cash flows and balance sheets, and assessing relevant footnotes, for the target company. This includes identifying non-recorded assets, hidden liabilities or overstated revenues that can negatively impact the value of a business.
Operational due diligence is, on the other hand is focused on a business’s ability to operate independently of its parent company. AaronRichards examines a company’s capability to expand operations and improve supply chain performance and improve capacity utilization.
Management and Leadership – This is a key part of the due diligence as it reveals the importance of current owners in the company’s success. If the company was established by a family, for instance, it’s important to determine if there’s any hostility or inability to sell.
Investors are looking at the value of a company’s long-term prospects in the valuation phase of due diligence. There are many ways to do this, therefore it’s essential that a valuation method is carefully selected based on the size of the company and the type of industry that is being evaluated.