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If your emerging company is exploring merger or acquisition opportunities, it is critical that you conduct extensive due diligence before finalizing any deals. Due diligence provides valuable insights about the road ahead, helps you assess whether deals fit, and can assist with risk mitigation.
While the basics of due diligence are relatively similar regardless of company size, start-ups must be particularly thorough, as a single misstep could pose a significant risk to business continuity. With that in mind, let’s explore the seven core components of due diligence for start-ups and emerging companies.
Broadly speaking, due diligence is the process of auditing, investigating, verifying, and analyzing the specific details of any investment opportunity or M&A transaction proposal.
Due diligence is typically performed by both parties and involves examining financial data and any relevant facts about the entity in question. Typically, the due diligence period lasts between 30 and 90 days, providing either party with an opportunity to cancel a deal should they discover details that concern them.
Ultimately, it is the buyer who reaps the majority of the benefits of due diligence, although the process can still prove beneficial to the seller.
Whether you are performing due diligence as a buyer or seller, it is important that you address each of the seven components detailed below:
The financial component of due diligence examines a company’s fiscal history, as well as its estimated future performance. Typically, the buyer will analyze the other entity’s income statements, cash flow statements, and balance sheets from the past 12 months, assessing the overall financial health of the company to ensure it is stable and profitable.
Additionally, the buyer will run financial projections for the coming fiscal year while also analyzing the company’s capital structure, budgeting processes, accounts payable and receivable reports, and its historical forecast accuracy. Ideally, the results of financial due diligence will indicate that the company’s value closely aligns with the agreed-upon purchase price.
Although financial data is a foundational element of due diligence, it does not tell the whole story, which is why the process also involves a comprehensive examination of the new entity’s customer base as well. The buyer will examine the other company’s top ten customers over the previous three years, identify any strategic partnerships, and determine the average per-customer revenue.
During the analysis, the buyer will also identify and examine any strategic relationships that have been terminated over the past three years. If the seller has cut ties with their leading customer, especially recently, it may have a significant impact on their future revenue, especially if that customer has not been “replaced.”
Examining the products and services that a company offers can help a buyer understand their growth potential. As part of the process, assessors will list all currently offered services and products, including average margins and current retail price.
The products, services, and competitiveness aspects of due diligence are often performed as a joint assessment. As such, the buyer will identify any competitors that sell similar products or services, list what they charge for the items, and compare pricing models. After the merger, the buyer will use these insights to adjust price points and make the company’s products and services more appealing.
Another part of due diligence involves the buyer assessing the competitive landscape that the other company currently operates within. They will make a detailed list of their potential purchase’s top competitors, rank each of them, and list their strengths and weaknesses.
The acquiring or investing organization wants to know what the seller’s potential for growth is. Therefore, assessing the competition can reveal how difficult or easy it would be for the company to scale within its current market. If a company is facing stringent competition and the market is saturated with providers, any deals will be less appealing to buyers.
During operational due diligence, buyers will consider all aspects of a company’s functions, including its warehousing, logistics, returns management, manufacturing, and the supply chain as a whole.
They will also take stock of auxiliary and support assets, such as IT service providers and systems, along with any physical assets. If a company is performing well and generating healthy revenue but is built upon aging or unstable infrastructure, it may be a risky investment.
The marketing and sales component of due diligence provides insights into a company’s brand image, market visibility, and current advertising strategy. Investing in an established brand with a strong social media following, a catchy slogan, and a strong sales funnel, for instance, is more appealing than merging with a business that needs a total rebrand.
During their marketing and sales analysis, the buyer will also examine churn rates, customer-level profitability, and the health of the sales pipeline. In addition, they will take a deep dive into the sales cycle, plan for new hires, and begin to create a post-merger marketing plan.
Both the line-level staff and management personnel of any company are its lifeblood. As such, buyers want to ensure that they are investing in or merging with an organization that has an established, talented, happy, and ultimately effective workforce.
Here, buyers will examine the organizational chart, analyze headcount by location and function, assess annual salaries, and review all compensation arrangements, including benefits and profit-sharing plans.
Performing due diligence can quickly grow into a monumental task, especially for smaller teams, but fortunately, you can streamline your approach to due diligence in your merger and acquisition (M&A) transactions by implementing scalable entity management software like Athennian.
With Athennian, you can consolidate your documents, successfully navigate the M&A transaction process, and make your business more appealing to prospective partners. To learn more about due diligence for startups, download our free Due Diligence Checklist. You can also book a demo of Athennian entity management software and further explore how we can support your company’s continued growth.
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