Comprehensive Due Diligence Checklist for 2023

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By the time the due diligence process begins, you have basic company information in hand. You know the year, make, and model of this company but due diligence is the opportunity to open the hood and see what’s really going on underneath the surface.

There are 6 types of due diligence: 

1. Financial 
2. Operational
3. Commercial 
4. Legal
5. IT
6. Environmental

But before you begin any of these, you need to have a process in place for 1) How will documents and information be securely shared? And 2) Where will these documents be organized and available for your team to review?

Documents You’ll Need

The specific documents required will vary depending on industry and type of transaction, however, here are some of the documents that are commonly required:

Legal documents:

• Articles of incorporation and bylaws
• Contracts and agreements with customers, suppliers, and other third parties
• Employment agreements and related documents
• Intellectual property registrations and related documentation
• Permits, licenses, and regulatory filings

Financial documents:

• Audited financial statements for the past three years
• Tax returns and related documentation
• Financial projections and budgets
• Capital expenditure plans and budgets
• Accounts payable and accounts receivable ledgers

Operational documents:

• Organizational charts and related documentation
• Marketing materials and related documentation
• Sales data and customer lists
• Inventory reports and related documentation
• Manufacturing and production reports

Other documents:

• Board meeting minutes and related documentation
• Litigation and claims history
• Insurance policies and related documentation
• Environmental and safety reports

Before starting the process for each due diligence step below, your firm should have a clear understanding of your point of contacts for company data and the timeline for your due diligence to be completed. You will inevitably run into slowdowns, but having these two pieces of information will help elevate bottlenecks.

With an organized process in place and a secured, shared location for important documents, below are the questions dealmakers need to ask at each stage of the due diligence process.

Financial Due Diligence

Financial due diligence involves reviewing the target company's financial statements, tax returns, cash flow, assets, and liabilities. 

The objective: identify any potential financial risks, such as hidden debts, unfunded liabilities, or unreported expenses.

Here are the questions to consider asking during financial due diligence:

• Can you provide copies of the target company's audited financial statements for the past three years?
• Have there been any significant changes in revenue, profit margins, or expenses over this period?
• Are there any unusual or one-time expenses that could impact the target company's financial position?

• What is the target company's cash flow like, and is it sustainable?
• What are the key drivers of the target company's cash flow?
• Are there any cash flow risks or contingencies that need to be addressed?

• What assets does the target company own, and are they valued correctly?
• Are there any assets that are not being used efficiently or that could be divested?
• What liabilities does the target company have, and are they accurately recorded?

• What are the target company's revenue streams, and how are they generated?
• What is the customer retention and churn rates? Are there any concentration risks?
• What is the current and historical customer acquisition cost?
• What is the sales pipeline like, and is it sufficient to support future growth?

• What is the target company's capital expenditure plan, and how will it be funded?
• Are there any major capital projects that are underway or planned?
• Are there any capital expenditure risks or contingencies that need to be addressed?

• What is the target company's working capital position, and is it being managed effectively?
• Are there any working capital risks or contingencies that need to be addressed?
• What is the target company's inventory management process like?

‍Operational Due Diligence

Operational due diligence involves reviewing the target company's operations, including production processes, supply chain, management structure, and employee benefits. 

The objective: identify any potential operational risks, such as inefficiencies or lack of scalability.

Here are the questions to consider asking during operational due diligence:

• How does the target company generate revenue, and what are the key drivers of its business?
• What are the target company's core competencies, and how do they differentiate it from competitors?
• What are the target company's key operational risks, and how are they being addressed?

• What is the target company's organizational structure, and how does it support its business operations?
• What is the target company's management structure, and how are key decisions made?
• Are there any organizational issues that need to be addressed, such as redundancies or conflicts of interest?

• What is the target company's supply chain like, and how is it managed?
• Are there any critical suppliers or vendors that could pose a risk to the target company's operations?
• What is the target company's inventory management process like, and are there any inventory risks or issues?

• What technology and systems does the target company use to support its operations?
• Are these systems up-to-date and scalable, and are there any risks associated with them?
• Are there any critical systems or processes that could pose a risk to the target company's operations?

• What facilities and equipment does the target company own, and are they being used efficiently?
• Are there any maintenance or repair issues that need to be addressed?
• Are there any risks associated with the target company's facilities or equipment, such as safety or environmental risks?

Underneath the umbrella of operational due diligence is an essential part of any business: human resources. Here are 3 major questions to ensure you’re incorporating HR into your operational due diligence properly.

• What is the target company's approach to human resources, and how are employees managed and developed?
• Are there any key employees or management team members that are critical to the target company's operations?
• Are there any HR risks or issues that need to be addressed, such as compliance with labor laws or employee turnover?

Commercial Due Diligence

Commercial due diligence involves evaluating the target company's market position, customers, competitors, and growth potential. 

The objective is to identify any potential commercial risks, such as changing market trends or loss of market share.

Here are the questions to consider asking during commercial due diligence:

• What is the target company's market share in its industry, and how has it changed over time?
• What are the target company's key competitors, and how do they compare in terms of market share, products/services, and pricing?
• What is the target company's competitive advantage, and how sustainable is it?

• Who are the target company's key customers, and what are their buying behaviors and preferences?
• What are the target company's core products/services, and how do they compare to competitors?
• What is the target company's product/service development pipeline, and how does it align with market trends?

• What is the target company's sales process, and how effective is it?
• How does the target company market its products/services, and what is the ROI of its marketing efforts?
• What is the target company's distribution strategy, and how effective is it?

• What is the target company's revenue and profit growth rate, and how does it compare to industry benchmarks?
• What is the target company's pricing strategy, and how does it compare to competitors?
• What are the target company's key financial risks, and how are they being addressed? 

• What are the key trends in the target company's industry, and how are they impacting the market?
• What are the key regulatory risks facing the target company, and how are they being managed?
• How does the target company's business model align with emerging industry trends and regulations?

‍Legal Due Diligence

Legal due diligence includes reviewing the target company's contracts, agreements, licenses, permits, intellectual property, and legal structure. 

The objective: identify any potential legal risks and liabilities.

Here are the questions to consider asking during legal due diligence:

• What is the legal structure of the target company?
• Are there any shareholders' agreements or other legal arrangements among shareholders?
• Are the company's articles of incorporation and bylaws up-to-date and compliant with applicable laws?

• What contracts and agreements does the target company have in place, such as customer contracts, vendor agreements, and employment contracts?
• Are these contracts assignable or transferable to the acquirer?
• Are there any change of control clauses that could be triggered by the acquisition?

• What intellectual property does the target company own, such as patents, trademarks, copyrights, and trade secrets?
• Are there any pending or threatened claims of infringement or misappropriation?
• Have the target company's intellectual property rights been adequately protected and enforced?

• Have there been any regulatory investigations or enforcement actions against the target company?
• Are there any pending or threatened legal claims or disputes that could result in fines or penalties?

• Is the target company involved in any litigation, arbitration, or other disputes?
• Are there any pending or threatened legal claims or disputes that could impact the target company's financial position or reputation?
• Have any judgments or settlements been entered against the target company?

• Are there any outstanding loans, liens, or encumbrances on the target company's assets?
• Are there any undisclosed liabilities or contingent liabilities, such as product warranties or pending legal claims?
• Have there been any material changes in the target company's financial position since the last audit?

IT Due Diligence

Information technology due diligence involves reviewing the target company's information technology infrastructure, cybersecurity, and data management practices. 

The objective: identify any potential IT risks, such as outdated systems or vulnerabilities that could lead to data breaches.

Here are the questions to consider asking during IT due diligence:

• What is the target company's IT infrastructure, and what is the age and condition of its hardware and software?
• What is the target company's network architecture, and how is it designed to support the business?
• What are the target company's software and hardware maintenance processes, and how are they managed?

• What security measures does the target company have in place to protect its IT systems and data?
• What is the target company's disaster recovery and business continuity plan, and has it been tested?
• What is the target company's policy on data privacy and protection, and how is it being implemented?

• What is the target company's IT organizational structure, and how does it align with the business needs?
• What is the target company's IT staffing model, and how does it support the business?
• What is the target company's IT training program, and how does it ensure that staff have the necessary skills to support the business?

• What is the target company's compliance posture with respect to relevant laws, regulations, and industry standards?
• What is the target company's policy on information security, and how does it align with industry best practices?
• What is the target company's policy on data retention, and how is it being implemented?
• What is the target company's IT strategy, and how does it align with the business strategy?

• What are the target company's IT investment priorities, and how are they being funded?
• What are the target company's plans for IT system upgrades or replacements, and what is the timeline for these projects?

Environmental Due Diligence

Environmental due diligence involves reviewing the target company's environmental compliance, liabilities, and risks. 

The objective is to identify any potential environmental risks, such as hazardous waste or contaminated land.

Here are the questions to consider asking during environmental due diligence:

• What environmental permits and licenses does the target company have, and are they up-to-date and in compliance with applicable laws and regulations?
• What environmental regulations apply to the target company's business, and how is the target company ensuring compliance?
• Has the target company received any environmental violations or notices of non-compliance, and if so, how were they addressed?

• What potential environmental liabilities does the target company have, such as contamination or remediation costs?
• Has the target company conducted any environmental site assessments or remediation activities, and what were the findings?
• Are there any ongoing or past litigation related to environmental issues, and if so, what is the status?

• What potential environmental risks could affect the target company's business, such as climate change, natural disasters, or regulatory changes?
• Has the target company conducted any risk assessments related to environmental issues, and if so, what were the findings?
• Does the target company have any insurance coverage for environmental risks?

• What environmental management systems and procedures does the target company have in place, such as waste management or pollution prevention?
• Does the target company have an environmental management or sustainability program, and if so, what are its goals and metrics?
• How does the target company ensure that its suppliers and contractors comply with environmental regulations?

Next Step: Integration Planning

Once the due diligence is complete, an integration plan is needed to incorporate the target company into the acquirer’s financial and cultural operations.

In order to create an effective integration plan, you need to define strategic objectives, identify the integration stakeholders, and establish metrics and milestones. 

None of these steps should be a surprise to the acquired company. The most successful acquisitions are clear and upfront with their goals. Your integration plan should echo the objectives shared in the very first call.

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