Pre-Diligence: De-Risking in the Pre-Transaction Window

A critical pre-transaction activity is de-risking. De-risking the business includes addressing issues that affect a buyer’s perception of risk. At face value, de-risking helps the business owner remove any threat from his assets and business operations. Critically, it is also one of the core principles of value creation, as value is a function of earnings, growth, and risk.

One way to begin de-risking a business is to complete a pre-diligence exercise illustrated in the checklist below. This exercise ensures a comprehensive review to determine the documentation status, ensure a common understanding of the documentation and identify areas of risk that may be resolved or overcome pre-transaction.

  • Clear, unambiguous documents related to corporate matters.
  • Clean and updated financial records.
  • Structured and well-documented human resource matters.
  • The clear bifurcation between personal and business property and clean property documentation.
  • Detailed paperwork of litigation-related matters.
  • A comprehensive list of the business’s intellectual property and its status.
  • All agreements, forms, and other documentation related to sales and marketing.

Related: Due Diligence During a Pandemic. 

Corporate Documents

A company needs to ensure that all the written agreements memorializing the terms of its key relationships are in place. If the ownership of the company changes, ensure it is clear whether such a change will trigger a termination right. The following list includes the types of documents that should be reviewed and indexed in this step:

  • The Company’s Operating Agreement, Articles of Formation, and a schedule of all the amendments.
  • The Company’s minute book contains all minutes and resolutions of executive committees, shareholders and directors, and other governing groups.
  • LLC Units ledger as well as copies of Units certificates that the Company has issued.
  • LLC members list specifying name, address, number of shares, the price paid, purchase date, name of the seller if it is other than the Company, exercise price, expiration date with a clear bifurcation of currently outstanding options/warrants.
  • A list of other rights holders to acquire the Company’s equity interests, specifying name, address, issuance date, description of rights, exercise or conversion price, and other relevant terms and conditions.
  • Copies of all agreements relating to voting trusts, convertible securities, options, calls, puts, subscriptions, and warrants.
  • All agreements relating to the sale of business assets or voting of membership units, including buy-sell agreements and members’ agreements.
  • All agreements, which may restrict the Company’s ability to issue or redeem its securities, assume additional indebtedness, sell, lease, or transfer its assets or capital stock.
  • Documents giving any person the rights related to issued or unissued membership units, including without limitation, rights of purchase or sale, rights of first refusal, or preemptive rights, registration rights, warrants, convertible securities, or options.
  • All agreements and other documentation concerning repurchases, redemptions, exchanges, conversions, or similar transactions for the Company’s securities.
  • All material communications to shareholders, unitholders, or equity holders since the Company’s formation, including annual and quarterly reports.
  • A list of all the verbal arrangements made between the Company and its shareholders.
  • All documents, reports, and analyses relating to any equity investment in the Company or any business combination with the Company.
  • Samples of all the certificates approved by the Board of Directors and those that represent securities.
  • A list of each jurisdiction, both domestic and foreign, in which the Company does business, i.e., it makes sales, operates a sales office, or where its employees reside, and a summary of the Company’s activities in each jurisdiction.
  • A list and organizational chart of all subsidiaries, affiliates, parent, or predecessor entity of the Company, specifying corporate name, state of formation, relationship to the Company, and the percentage ownership of voting securities.
  • Copies of all offering memos, business summaries, and other materials and information prepared for or delivered to potential purchasers of the Company or otherwise used in connection with any prior proposed sale of the Company.
  • All agreements, memoranda, and any other documents about any bankruptcy proceedings the Company has been involved in.
  • Documents relating to all previous or contemplated acquisitions and dispositions by the Company.
  • Any business plans of the Company.
  • All development and licensing agreements are related to the joint venture, participation, partnership, or cooperative.
  • All material information that the Company possesses relates to other companies in the same industry.
  • A schedule of all memberships held by or on behalf of the Company in any professional or industry-related organizations or associations, including those of trade and merchants’ marketing.
  • A schedule of all the professional engagements made by the Company like law firms, accounting firms, consulting firms, etc., during the past five years.

Required documents related to government regulation:

  • Schedule of all material licenses, authorizations, consents, permits, qualifications, and approvals issued to the Company by any United States federal, state, municipal, foreign, or other governmental authority in connection with the operation of the Company’s business (collectively, “Permits”).
  • Copies of all Permits described above.
  • All correspondence or documents concerning any proceedings with a regulatory agency.
  • All approvals or refusals received from any federal, state, municipal, or foreign regulatory authorities concerning the business or assets of the Company within the past five years.

Financial Records

The financial records of a company speak volumes about its health. In the absence of audited financial statements, buyers prefer that the business has professionally reviewed financials over internal ones. Sloppy financial statements are seen as risky by both lenders and buyers.

Financial records can be grouped into four broad categories: general or primary, debt-financing, tax, and insurance documents. In this step, review the following to ensure documents are available and up to date.

General Financial Information:

  • Financial statements for the past five years, such as P&L, BS, and Cash Flow Statements.
  • The latest balance sheets, the projected income statements, and the cash flow statements, as well as all the assumptions.
  • A schedule of all indebtedness and contingent liabilities.
  • A schedule of inventory.
  • A schedule of accounts receivable.
  • A schedule of accounts payable.
  • Any changes in accounting methods in the past five years.
  • An explanation of depreciation and amortization methods used in the business.
  • Schedule all liabilities and obligations not appearing on the Company’s balance sheet, including all unasserted and threatened claims and such matters as leases, guarantees, letters of credit, unfunded pensions, deferred payments, off-balancing sheet financings, etc., and copies of all related agreements.
  • The Company’s general ledger.
  • All audited financial statements for each of the last five fiscal years and the latest unaudited interim monthly and quarterly financial statements were prepared since the date of the most recent audited financial statements.
  • Operating budgets and strategic plans for the past five fiscal years and any reports or papers relating to any long-term budget, capital development, restructuring program, or strategic plan, including any plans regarding systems and operations.
  • Summary of the Company’s accounting policies (to an extent different from GAAP).
  • Accounting records to be transferred (including customer lists, accounts receivable at transaction closing date, assignable data processing programs, stock/securities received in settlement of claims).
  • Description of and reasons for any change in accounting methods or policies since the Company’s formation.
  • Any analysis of fixed and variable expenses.
  • An analysis of gross margins.
  • Details of historical and planned capital expenditures.
  • Accounts payable and accounts receivable aging reports for the past five years.
  • Any other reports prepared for management.
  • Schedule of items comprising accrued tax liabilities and accountants’ work papers related to tax liabilities, including tax “cushion” calculations.

Documents related to debt-financing:

  • A schedule showing all outstanding debt of the Company, as of a recent date, including capitalized leases.
  • All agreements relating to debt incurred by the Company that is convertible into equity.
  • All agreements relating to other debt incurred by the Company, including agreements to acquire any debt obligations of others and deals relating to leasing transactions of a type required to be capitalized as per GAAP.
  • All agreements, where the Company acts as a guarantor, surety, co‑signer, endorser, co-maker, or otherwise in respect of the obligation of any other person.
  • All agreements entered into by the Company oblige it to invest in some other entity in the form of a loan, capital contribution, or otherwise.
  • A detailed description of any defaults of the Company relating to any existing or prior debt obligations of the Company.
  • Loan agreements entered into by the Company with brokers, investment bankers, and finders.
  • All material correspondence with and from lenders since the Company’s formation.
  • Outstanding material financing arrangements and all other agreements the Company has entered into during the last five years.
  • The documents of all the bank financing arrangements, loan agreements, promissory notes, and line of credit, the Company is a party.

Tax information:

  • Federal, state, local, and foreign income tax returns for the last five years.
  • States sales tax returns for the last five years.
  • Any audit and revenue agency reports.
  • Any tax settlement documents for the last five years.
  • Employment tax filings for five years.
  • Excise tax filings for five years.
  • Any tax liens.

Professional business valuators must diligently audit the company’s tax filings and registrations to ensure that it is paying taxes in all required jurisdictions.

Insurance documents:

  • A schedule and copies of all insurance policies of the Company or self-insurance arrangements, including professional liability, officers’ and directors’ liability, key-man life insurance, property, liability, business interruption, and product liability, specifying coverage limits and other significant terms.
  • A schedule of all insurance claims submitted by the Company since its formation.
  • A copy and schedule of all the insurances of the Company, including general liability, product liability, directors and officers, key-man, worker’s compensation, personal and real property, errors and omissions, and many others.
  • A document giving clarity on the history of the Company’s insurance claims for the past three years.

Businesses need to ensure that they have sufficient insurance in place to cover potential liabilities.

Human Resource Matters

Understanding the individuals who make up a company and their roles is another area of concern for potential buyers. For example, has the company incentivized its critical employees to help with the company’s growth after a change of ownership? Consider the following human resource management matters:

  • Schedule of employees and consultants detailing all salaries, bonuses, and non-cash compensation, such as the use of scooters, property, etc., paid during the last three years and the entire years of service.
  • All employment agreements, consulting agreements, and offer letters, which are in effect currently.
  • Resumes of key employees and their job descriptions.
  • A current organizational chart of the Company listing all current employees, specifying each person’s title, department, functional area, and job description.
  • All agreements for loans, guarantees, or material transactions with any officer, director, employee, or unitholder and their immediate families.
  • The Company’s personnel handbook and a schedule of all employee benefits, including holiday, vacation, and sick leave policies.
  • Employee manual or other literature regarding policies, procedures, and benefits distributed to employees of the Company.
  • All non-disclosure or non-competition agreements related to the Company.
  • All employment contracts to which the Company has been a party in the past five years.
  • Material agreements with any employee, consultant, or director, past or present.

In addition, the Company also needs a deep analysis on matters related to employees’ grievances, legal issues, insurance matters, benefit plans, union Matters, and possibly much more.


The checklists shared here are a starting point for de-risking.

Depending on the circumstances, hiring professionals to assist with de-risking may make sense and, thereby, grow value for a business. While many owners feel that they can go through the entire process on their own and manage it, the process diverts them from their core objective, which is carrying out business as usual.

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Author Summary:
Dan Doran

Dan Doran

Is the Founder of Value Scout, Quantive and the 2019 Exit Planner of the Year. He is a recognized expert and speaks frequently about M&A, valuations, and developing more deliberate value creation strategies.

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