‘Due diligence’ means ‘due care’ or ‘duty of care’. The term is now used primarily in the context of the purchase of a company and refers to the careful examination of the target company by the prospective buyer.

For their part, sellers would be well advised to subject their own company to due diligence in advance. The aim of due diligence is primarily to uncover financial risks for the buyer. On the other hand, the buyer also hopes to identify opportunities through due diligence, for example synergies with their existing business areas. This makes due diligence the most important tool for decision-making and determining the purchase price.

The 5 Aspects of Due Diligence

Depending on the industry, the individual characteristics of the company and the investor's objectives, the due diligence process takes place in different ways. However, it generally covers these five areas and topics:

• Financial situation: The balance sheet and income statement are examined, and the cash flow statement, assets and equity are evaluated and a forecast of earnings and cash flow is prepared. The financing structure is also analysed.
• Market and competitive environment: What is the company's position within the industry, how is the market developing and how well is the company positioned for future business?
• Business model and value chain: This includes not only an assessment of the risks associated with supplier and customer relationships, but also the opportunities for increasing efficiency, saving costs and exploiting synergies.
• Legal aspects: This involves a meticulous review of the relevant company documents (e.g. articles of association, entry in the commercial register) and important agreements (e.g. supply contracts, employment contracts), analysis of liability risks, and, if applicable, risks in connection with ongoing legal disputes.
• Tax aspects: What are the tax implications of the company purchase, how high is the current tax assessment, are there any ongoing tax audits, outstanding objections, outstanding tax payments?

In addition, the condition of machinery and equipment, rights to use patents or licences, as well as ecological factors and cultural challenges, can also be the subject of a due diligence review. The question of how sustainably the company operates in terms of the environment, social issues and management culture is also becoming increasingly important.

Discretion is Paramount

In order to be able to examine a company with the necessary care, the prospective buyer needs extensive documentation, which the seller is obliged to provide as soon as they have expressed an interest in buying the company. Due diligence also includes site visits and discussions with management and key employees.

Much of the information required for the due diligence is confidential. For example, innovations from product development can sustainably improve business prospects and thus the value of the company. To ensure that such data does not fall into the hands of the competition, all of the investor's employees working on the due diligence should sign a confidentiality agreement (NDA: Non Disclosure Agreement).

Preparation of the Seller

A great many details are requested as part of a due diligence review. Incomplete documents or incorrect information reflect badly on the seller and adversely affect a positive company valuation.

It is therefore advisable for a business owner to first conduct a due diligence review of their own company. This ensures that all the necessary information is compiled correctly and completely and stored in the (virtual) data room. It significantly simplifies and shortens the subsequent review process as part of an actual sales process – for both the seller and potential buyers. In addition, a pre-due diligence review may reveal weaknesses in the company that can be advantageously eliminated before negotiations begin. As a general rule, the better a business owner prepares for a potential investor's due diligence, the stronger their position in the negotiations.

Specialists are in Demand

A due diligence is a time-consuming undertaking and also requires some specialised knowledge. A buyer who, as a managing director, has to take care of his own business will have no choice but to delegate due diligence tasks to competent employees or external specialists. A whole team is needed, consisting of industry specialists, auditors, lawyers, tax experts and financial analysts. Professional financial investors usually employ such experts; a founder who has built up a company and now wants to sell it does not.

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