Is Due Diligence Necessary?

Once you have found the right company for corporate succession, the next step is detailed planning. In addition to the due diligence check, this also includes the creation of a continuation plan. We’ll show you what to consider and how you can master these steps on the way to take over.

Due Diligence Phases

In the context of corporate succession, due diligence refers to the thorough examination of the business when a company transitions to new management. The audit focuses on the economic, legal, financial, and tax conditions of the company. Particular attention is paid to the sales and earnings situation and possible cases of tax evasion or white-collar crime.

The due diligence process consists of three phases.

  • Phase I: Analyze the company’s business model.
  • Phase II: Verify or disprove the owner’s claims regarding the company. For example, if the company is a factory, this phase would entail checking whether the machines in the company are up to date and still working correctly.
  • Phase III: Take an in-depth look at the company’s financial affairs.

Why is due diligence necessary for succession? When planning a transition to new management, you must first obtain a comprehensive picture of the company and all operational conditions. This helps to prevent surprises and to assess the company value and necessary investments correctly. At the same time, a look at the figures also enables a forecast for the company’s future development.

Get professional advice. As the first step in due diligence–or the case of succession in general–we recommend finding a suitable advisor. Expert guidance helps avoid mistakes arising from ignorance: not knowing what you don’t know gives rise to overlooked figures and misunderstandings. A consultant specializing in corporate succession knows the pitfalls and what to look out for, so the handover is successful. However, specialized management consultants are recommended here; lawyers and tax consultants are also good contact points for future successors.

Related: What is Vendor Due Diligence?

Critical Points of Due Diligence

The following aspects make it easier for you to estimate a realistic purchase price for the company takeover. This results in a transparent negotiation basis in which both sides can speak openly about the price.

1. Starting Point

Why does the seller want to sell the company? The following reasons often play a role in handing over a company:

  • Retirement
  • Illness
  • Reorientation
  • Lack of money
  • Death resulting in the sale by the heirs
  • Business failure.

All of these reasons are special circumstances that must be dealt with accordingly in the event of a takeover. For example, a failing company requires greater investment than the upcoming retirement of the owner.

2. SWOT Analysis

A SWOT analysis of the company provides information about possible next steps after the company takeover. Can existing risks and weaknesses be balanced out with the help of strengths and opportunities, or are the company’s problems too significant?

3. Reputation and Image

What is the company’s reputation? Find out what customers, partners, and suppliers think of the company. Improving a bad reputation costs a lot of time and money after the takeover.

4. Location

Does the location meet all the requirements relevant to the industry? In the manufacturing industry, location encompasses production facilities, machines, and equipment. A disadvantageous location, such as a contaminated site that requires remediation of pollutants can cost you dearly. Remember that, from a location perspective, manufacturing companies or businesses handling toxic materials (e.g., used motor oil) must be treated differently than retail or office buildings.

5. Market

Get an overview of the market volume as well as the estimated future market growth. Include details such as market growth, risks of stagnation, and changes in customer needs and customer behavior. These market estimates and the company’s competition help predict sales and earnings figures for the next few years.

6. Customers

Because customer retention is less expensive than customer acquisition, taking over the existing customer base is distinct from starting from scratch. However, use the company’s customer database to sort and identify the actual size of its customer base. Another point is customer loyalty: how much does it depend on the old owner? Get an overview of regular and long-term clients and let the seller introduce you to them as the corporate successor.

7. Competition

Compare the company to similar companies in the same market space to identify its market position and industry development trends. Direct comparison with the competition also reveals any deficits that must be addressed to ensure or restore the business’ financial good health. It is also essential to look ahead: Can the products or services still hold their own when new business ideas and competitors conquer the market? Do not rest on the company’s laurels, but plan improvements to the product. Value Scout provides a tool that helps you analyze the competition.

8. Finances

Much of the advice and analysis relating to succession pertains to the company’s financial situation. When you take over a company, you also take over its finances. This is a particularly sensitive aspect of business, which is why it needs to be carefully scrutinized. Get an accurate picture of all liabilities so that you don’t face a mountain of debt after the takeover. Take a good look at the cash balance, possible loans, the equity ratio, and the sales and earnings positions.

9. Product or Service

Since the product or service already exists, you are not forced to design your products or services and bring them to market. However, you should consider the potential development of the product or expansion of the service after succession, because the competition never sleeps.

10. Staff

Successors also take over the staff and take responsibility for those jobs. Inquire about salaries, bonuses, and paid leave during the due diligence. Staff satisfaction and willingness to stay with the company after the takeover should also be considered. Take into account aspects such as employees age, because if many employees are about to retire, you will have to look for replacements soon. An expert in labor law can help assess the situation.

11. Suppliers

Corporate successors depend on existing supplier relationships because the reliable delivery of raw materials and supplies is extremely important. Therefore, you should ensure–not assume–that suppliers will continue to be available after the takeover or take measures for replacements at an early stage.

12. Articles of Incorporation

If a shareholder-owned company is to be transferred to other hands, the shareholders must generally agree to this. Take a look at the company’s articles of incorporation. Also, make sure that the previous owner is fully vested in ownership. If this is not the case, both the seller and buyer are liable for shares not paid.

13. Rights

Industrial property rights ensure you have the opportunity to use product ideas or the like. This is how you can secure competitive advantages. To ensure that copyrights, intellectual property, patents, and other critical rights transfer to the new owner after the takeover, find out how long the property rights are still valid and when they have to be extended. Consult a patent attorney.

14. Insurance

Find out what insurance policies have been taken out and which ones may also be required. The previous owner must inform the insurance companies of the successor in good time so that the contracts can be transferred to you without disruption of coverage.

Resolve Conflict Through Open Communication

The different interests and needs of the parties involved in a company takeover are usually common in negotiations. The current owner (i.e., seller) and the successor (i.e., buyer) want to see their interests represented, leading to conflict. Hence, due diligence becomes necessary to avoid and resolve such disputes.

The COVID-19 pandemic illuminated different aspects and risk factors, which should not be forgotten after the crisis. It can be expected that risk-minimizing measures from which all parties involved can benefit will gain in importance. Expect these measures to be found much more frequently in future sales contracts.

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Makalyn Feaster

Makalyn Feaster

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