Due Diligence Reviews

Topics of inquiry or concern will include the following:

• historical financial statements
• target projections / future performance
• foreign subsidiary influences
• monthly patterns
• liabilityes: current, non-current, contingent
• internal controls
• business growth phase analysis
• financial projection reasonability
• board approvals
• working capital assessments
• R&D investments
• capital expenditures and commitments
• tangible assets and liens
• debts – terms, guarantees
• revenue recognition issues
• aged receivables, doubtful debts
• liquidity
• audit qualifications
• operating/tax losses

This due diligence will often focus on the following areas of inquiry, among others:

• extent and quality of technology and intellectual property
• IT systems adequate for current and future needs?
• domestic and foreign patents
• confidentiality agreements
• invention assignment agreements – current and formal employees and consultants
• registered and common law trademarks, service marks
• copyrighted products and materials
• trade secrets preservation
• infringements of own or others
• intellectual property litigation or disputes
• technology in-licences, royalty obligations
• third party exclusive technology licences
• open source software issues
• software critical to operations – appropriate licences
• source or object code disclosure reuirements
• existence of indemnities on intellectual property
• liens or encumbrances
• grants or support from governmental authorites – obligations
• bugs and defects

Customer database and prospective customers can be one of the major parts of an investment. Topics of inquiry or concern will include the following:

• compensation and incentives of employees
• customer list in size order
• customer concentration risks
• retention of customers
• customer satisfaction
• warranty issues
• repair, indemnification, liquidated damages obligations
• customer backlog
• sales terms
• returns, exchanges refunds records

Increasingly important is a companies attitude and actions towards environmental issues, which are slowly becoming legislated. Where an environmental review is conducted, it will typically include a review of the following:

• environmental law investigations from public agencies
• environmental audits on properties (including neighbouring properties)
• hazardous substsance management
• environmental permits and licences
• EPA correspondence
• environmental disputes or litigation
• liabilities or indemnifications
• asbestos containment

Review of all material contracts including the following:

• approval required for change in control
• guarantees, loans, credit, hire-purchase arrangements
• customer contracts
• reseller and supply contracts
• joint venture, partnership contracts
• operating agreements
• settlement agreements
• past acquisition obligiations
• indemnification agreements
• HR agreements
• exclusivity agreemnets
• limitation on geographical sales agreements
• supplier and purchase agreements
• leases (real estate)
• licences
• franchises
• powers of attorney
• distribution and dealer agreements
• advertising agreements
• union contracts
• government contracts

Quality review of the seller’s management and employee base may include:

• employee debts and obligations assumed
• organisational chart
• discrimination policies, management or allegations
• culture issues
• labour disputes
• employment and contract agreements
• compensation schedule
• other means of compensation
• usage of company property arrangements
• benefits
• manuals and policies
• criminal proceedings
• civil litigation
• redundancy or temination plans
• non-compete clauses
• turnover history

Of significant importance is any litigation or arbitration matters that are on foot or pending. This review will include the following:

• matters in arbitration or mediation
• pending litigation, together with all complaints and other pleadings
• settled litigation and the terms of settlement
• threatened claims
• injunctions, judgments or orders
• insurance claims

It may be appropriate to bring in a third party expert for this part of the review, depending on the type of business under review.

At a minimum, the investigation should focus on the following:

• potential breaches, the level of significance and impact reach;
• network and system architecture and data flows analysis, including the use of cloud providers and third-party applications
• personal information gathering and policies surrounding privacy, considering regulations around this
• contractual obligations with customers, suppliers around privacy and cybersecurity matters
• review any prior cybersecurity incidents, including data breaches and consider response to these breaches
• consider organisational policies and controls in place, and adherance to these
• assess potential liability exposure

The buyer will often request and review copies of various policies, contracts, and other documents of the seller, including the following:

• systems of internal accounting controls to guard against fraudulent requests for money in place
• privacy policy documents
• privacy policy adherance
• review Terms of Use agreements
• marketing policy adherance
• security policies including Security Policy, Acceptable Use Policy, and Data Classification Policy
• review results of testing of security policies
• contracts with vendors, suppliers, providers
• critical incident response plans
• resilience to potential threats or breakdowns

Tax due diligence may include looking at prior tax and BAS returns. It may be relevant to look at carry-forward tax lossses and any adjustments made over the past seven years, and may also include:

• Tax sharing or indemnity agreements or arrangements
• Federal, state, local, and foreign tax;
• Government audits
• Copies of any correspondence or notice from any foreign, federal, state, or local taxing authority regarding any filed tax return (or any failure to file)
• Tax sharing and transfer pricing agreements
• Net operating losses or credit carryforwards (including how a change in control might affect the availability thereof)
• Agreements waiving or extending the tax statute of limitations
• Allocation of acquisition purchase price issues
• Correspondence with ATO, OSR
• Settlement documents with the ATO or other government taxing authorities
• Withholding tax compliance

Anti-trust and regulatory matters are increasingly an important consideration as implications could be significant:

• consider competition sensitivities;
• scope of anti-trust issues;
• approvals require in regulated industries;
• prior or current inquiries or investigations into antitrust or regulatory issues;
• foreign entity purchaser issues (if applicable)
• consolidation approval required (if applicable)
• consider any foreign control laws

Insurance policies, claims and potential claims will need to be considered including:

• Public liability insurance
• Cybersecurity insurance
• professional indemnity insurance
• intellectual property insurance
• motor vehicle and equipment/machinery insurance
• health insurance
• employee liability insurance
• worker’s compensation insurance