We have all heard the term Due Diligence, but what is it, and what does it include in a small(er) private business transaction/acquisition? Due diligence in such transactions is akin to the meat cutter at any Taunton, Plymouth, or Hyannis deli telling you of the great sale for $3.95/pound! But what is it? Dietz and Watson Roast Beef, Willow Tree Chicken Salad, or Krakus Polish Ham is a great sale! If it is bologna, not so much. Due diligence ensures that the buyer gets what he thinks and that the purchase price is fair.
The attorneys want to be sure that all representations and warranties are met that there are no contingent liabilities, no outstanding stock options or warrants, no known claims or pending lawsuits, that all real estate and equipment are owned free and clear, or that any encumbrance is identified and is verified.
Some REAL words. Attorneys can be reasonable at making money for themselves. However, the reality is that the extent of Due Diligence in a $15,000 purchase should not be the same as for a $15,0500,000.00 purchase. However, the basics remain the same, and in this blog, I will address some of the basics you should have covered.
The general sections that you will want to review are:
Business due diligence, legal, financial, and accounting owing diligence; background checks and due diligence; intellectual property, corporate governance, compliance, and ethic diligence; and privacy and data security due diligence.
No, the attorney should not be the only person involved in such a review. I have almost always retained the services of a qualified CPA to assist. In addition, with the explosion of IT issues, an experienced and trusted technology expert might want to be consulted.
Here is a summary of some areas that you should consider:
General Corporate Records: This includes certified corporate articles, bylaws, identification of States (and potentially countries) that the company does business in, those States (countries) registered agents, Corporate filings, Minutes of Board and Shareholder meetings, identification, and related documents of any subsidiaries and or affiliates of the business entity, stock ledgers, transfer books, cross-reference all stock transfers with corporate minute books and corporate votes, verification of payment for stock, any warrants, options agreements as to any security ownership and rights, any voting trusts, or irrevocable proxies, and any agreements related to stock transfer restrictions.
Financial Due Diligence and Accounting:
Audited financial statements (due to the effects of COVID on business, I would recommend at least four years), any interim/ quarterly reports and management letters by auditors, accounting methods used, any explanations for changes in accounting methods, accounting policies, and plans or votes on proposed, pending acquisitions, inventory schedules and how allocated, asset lists, profit, and loss reports, balance sheet reports, any non-GAAP financial measures used, why and authorization for such practice any existing business plan, any investment policies or company practices.
Taxes: Again, all State and Federal tax returns. (As with audited statements, I recommend at least four years better to understand the effect of COVID-19 on this business.) Any pending past audits, tax sharing agreements, payment plans, documents evidencing State Tax compliance, any correspondence from the IRS or State Dept. of Revenue (those guys!)
All deeds, mortgages, any interests in real property, any real property leases and subleases (as the lessee or lessor), any pending P&S and offers to buy, any options to buy, any Zoning or TIIF documents, any land use permits, any conservation rulings and certificates of compliance, most recent plot plans or surveys on real property owned, any appraisals on real property owned, or leased for the last 4-5 years.
Documents of title (ownership), bills of sale, assignments, any motor vehicle documents of the company, or any officer, director, trustee, owner, employee, any purchase money agreements, a listing of all machinery, equipment, soft and hardware (addressed below), any UCC filings, or any liens, or leases on such equipment.
Any Patents owned, patent applications (and details on each) similar to any trademarks, copyrights, a summary of any inventions, any NDAs related to IP (including documents signed by company employees), and identification of all company social media accounts.
Data Security and Confidentiality:
Company IT policies and practices, any internal audits or external reviews by IT staff, data security compliance reports, documents evidencing how the company retains and protects personally identifiable information, any software licenses, copies of any security systems, such as backups, firewalls, and contracts with IT entities.
Contracts and Financing Documents:
Vendor contracts, purchasing requirements, franchise agreements, significant suppliers and supply agreements, commissions, brokerage and agency contracts, marketing agreements, licensing agreements, construction agreements, any joint venture or partnership agreements, any agreements with employees, owners, Directors, Trustees, any governmental contracts, any loan agreements, and sale and leasebacks, mortgages, security agreements, pledges, any defaulted contracts, account payable and account receivables reports, for manufacturing entities: profit report by items made, cost reports, delays in deliveries, warranties with delivery services, any disputes or claims, including insurance claims.
Management and Personnel Matters:
Organizational charts, stock ownership listings, description of all contracts with employees, trustees, directors, and owners, the definition of family members involved in the company, including any employment contracts, indemnification agreements for officers, directors, trustees, all management contracts, Payroll records, payroll and consulting agreements and related reports, Profit Sharing Plans, Benefit plans, stock/option plans, retirement plans any deferred compensation plans; any bonus plans employment manuals, any fringe benefit programs, documentation of compliance with Immigration Reformed laws, any documents related to any labor relations or union activities.
Any company filings with State, Municipal, or Government authorities or agencies. Examples. EPA, OSHA, FDA, EEOC, Taxing authorities, software licensing, and franchise agreements.
Copies of all insurance policies for the company. Ex. commercial liability, product liability, worker’s compensation, D&O, property, cyber security business interruption, disability, professional liability, if needed, and known or suspected claims of any cancellations or premium increases over the past 4-5 years.
These are some issues that the attorneys should be prepared to present or review. Seasoned counsel must be involved because time frames to produce and review such documents are often tight. In addition, there are several other issues to consider, but as a discussion document. What say you?