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Due Diligence

NIC Document

Summary

Due diligence is the term used to describe the performance of an investigation of a business or person. This guide covers the key areas you need to cover to ensure that your company is prepared for the due diligence process.

In brief

  1. Constitutional and corporate
  2. Financial
  3. Commercial
  4. Technology and intellectual property
  5. Legal
  6. Directors and employees
  7. Environmental
  8. Regulatory

Introduction

Any company that is looking to raise money, float on the public markets, or sell out, will have to go through the due diligence process. The purpose of due diligence is to investigate a potential investment to support the valuation process. If you are planning to raise money through your company, you should be aware of the key issues, aim to keep information up-to-date and avoid decisions that may adversely affect the valuation of the company in the future. Due diligence can be a lengthy, time-consuming, and sometimes expensive process. In an investment or trade sale, the purpose of the due diligence process is often to drive the value of the company down so that the purchasers get a better deal. It is important to be aware that on completion of an investment, the directors of the company and any other sellers will be asked to sign covenants to state that the information they have provided is correct to the best of their knowledge. If the information provided is shown to be false, the investors will be in a legal position to regain their investment and potentially to begin criminal proceedings. During the due diligence process, investors will usually request information on the following areas:

Constitutional and corporate

The investor will be looking for information on how the company has been set up, the group structure, and details of all advisors. They will also want to see the certificate of incorporation, memorandum, articles of association, and the minute book. Share structure and current shareholders will be vital to most investors. Some types of share structure will invalidate schemes such as the Enterprise Initiative Scheme (EIS), which provides tax breaks to certain types of investor.

Financial

The potential investors will want to examine the financial history of the company. This will include the audited accounts for at least the last three years (if available) which will be compared with any forecasts that were made. All of a company’s assets and liabilities must be disclosed, including intangible assets, with their valuations and a basis for those valuations. The investors will also require either three or five year financial projections. To prepare for due diligence, it is advisable to ensure that the accounts are in a good state, the asset register is up-to-date, and that any information you present to investors is correct. You will also have to provide financial projections to show the likely return on investment for investors.

Commercial

The investors will also need to investigate all commercial aspects of the business. This section will examine the key customer accounts and revenue by product. If your company has received any grants or other financial assistance, this information, as well as the signed agreements, will be required. The investor will also want to examine any trade relationships and agreements to assess the commercial health of the business.

Technology and intellectual property

Intellectual property (IP) refers to any product of someone's intellect that has commercial value, such as copyrighted material, patents, and trademarks. IP is classed as an intangible asset so the investor will want to know as much about the IP owned by the company as possible. The investor will want to know the details of all IP, the status of the IP, any ownership issues, as well as whether the company is currently in litigation proceedings. Technology due diligence can be a more difficult process, as the concepts involved will often only be fully understood by specialists in the field. Many investors will rely on independent market research reports, IP information and discussions with the inventors.

Legal

A potential investor will want to examine all legal agreements that the company has made, such as confidentiality agreements, licence agreements, leases and contracts of employment. They will also want to know the details of any dispute in which the company is involved, such as staff tribunals, trade disputes, criminal conduct by any officer or employee, or contravention of any statutory or regulatory requirement.

Directors and employees

Staff are usually seen as the most important asset of any business. A potential investor will need information about the senior management and directors of your company. They will be interested in the employment history, structure, and staff turnover. They will also wish to look at any contracts of employment, and the company’s legal structure, such as staff handbooks, policies and procedures, internal regulations, as well as pensions, life assurance, and other benefits.

Environmental

Environmental issues can be a significant risk to the operation of a company. Depending upon the sector, there may be significant regulatory burdens around the control and storage of hazardous material, pollution and the disposal of waste. However, the investor will also be interested in a range of other issues. For example, you may have to prove that your company does not have any contamination issues on land that it owns.

Regulatory

You will need to convince your investor that your company understands the regulatory framework it works within, knows how it will affect the development and launch of products, and has everything in place to meet all its regulatory requirements.