Due diligence is an absolute necessity when investing in a company, by merger, acquisition or stock purchase. And due diligence is just as important for the target business, to make sure the suitor is a proper fit financially and ethically.
Are you investing in a hedge fund? Considering backing a startup as an angel investor? Evaluating potential international business partners? Due diligence should be performed in every one of those situations.
Even a decision to partner with a domestic company on a project, to obtain parts or services from the company, to finance their purchases from your inventory, or to otherwise conduct a significant amount of business with a firm carries with it a responsibility for due diligence. A partner or shareholders can take action against an officer or board for failure to perform due diligence to ascertain before making one of these decisions whether it was in the company’s — and stakeholders’ — best interests.
Entity due diligence reports conducted by Global Backgrounds are really a package of due diligence background checks. They can be performed as domestic or international due diligence reports. These are not the end of due diligence, but the beginning — a collection of facts that bear analysis by accountants, lawyers and other business advisors.
Findings in due diligence also allow you to give the subject of the report an opportunity to explain or expound on information that the report uncovers, whether it is favorable or unfavorable.
Let’s look at eight different things that we can provide in a due diligence report for you:
1. Identification and address verification
Is the company who it says it is? Or is the name you know a newer name that disguises past problems? Has the company conducted business using aliases?
A due diligence report will verify such information as street address, D-U-N-S number and the company’s Tax I.D. number. Other names identifying the company will stay with it, and they become increasingly important if there are liens or judgments filed against the company when it used another identity.
2. Corporate ties
Does the business you’re targeting have a financial interest in another corporation, or perhaps more than one?
Those other corporations may be privy to trade secrets of the business you want to buy or invest in, which could weaken the target company’s position. If stock in those companies becomes part of the transfer of assets, are those other companies as suitable as the target business is to become a part of your organization? Disclosure of these ties can help you decide if the fit is right and whether exposure is reasonable.
3. Property Details
The record of a business as a property owner or renter can convey a great deal about its character, financial health and flexibility.
First, does it own property? It’s important to examine deeds for such information as liens, covenants, conditions and restrictions. For instance, would a right-of-way prevent development of a property in a way that your planners envision? Would satisfying a lien add significant costs to the purchase? Would a restriction block the addition of a building or construction to desired square footage?
Assessments for any properties, which are public information, are useful indicators of value.
A due diligence report will check for a history of foreclosures. They would be a key indicator of financial distress.
If the business rents, it should be free of evictions, which also would blemish its financial condition. Knowing the existence of all leases affords an opportunity for examination. Ideally the lease should not present obstacles to moving the company if it’s deemed appropriate or to maintaining it at the rented site if that would be advantageous.
4. Bankruptcies
Perhaps no financial consideration is as far-reaching as a bankruptcy, which would be reported in due diligence findings. A bankruptcy could seriously hinder the ability of a business to borrow. It also could significantly add to the cost of borrowing, if financing can be arranged.
In a Chapter 11 filing, the company has a chance to reorganize. A firm that has emerged from bankruptcy might be stronger because it is leaner, offering attractive investment opportunities. It can also present risks, however, such as unresolved problems and stockholders waiting to divest themselves of shares after the company re-emerges, getting as much return as they
can before stock value falls.
5. Liens
Open liens must be paid before the sale, so knowledge of them is imperative. The due diligence report gives details such as the date, amount, debtor, and the reason for the lien. It lists the lien holder, the D-U-N-S number and the level at which the lien was filed, such as state or federal.
Perhaps the most common liens are tax liens, resulting from unpaid levies. Taxes left unpaid could be for anything from income taxes to franchise taxes or government-affiliated development fees. Liens also can result from unpaid judgments.
6. Judgments
A judgment issued by a court can limit actions by a business and its owners. The judgment makes it easier for a plaintiff who succeeded in winning a judgment to collect on the amount of money owed. It also will affect the business’s credit score and its ability to borrow.
If a business is privately owned and operated as a sole proprietorship, a judgment against the owner may snare the business in its web because it’s an asset of the owner.
Knowing if judgments exist and the amounts involved are important factors in putting a value on a company. Once liens are discovered, it’s important to understand what actions the business owners took to shield the business from judgments against them, and to shield assets from judgments against them or the company.
7. UCC filings
UCC filings are done under Uniform Commercial Code rules. Any business that’s borrowed money knows they are pretty much automatically filed by the lender as soon as a loan is signed.
It’s the type of UCC filing that is important:
Most UCC filings give the lender the primary claim against specific collateral, quite possibly the equipment that was purchased with the loan. For instance, a computer company may complete a UCC filing against the computers and servers it financed for the business that bought its products.
Less common but so much more far-reaching is a UCC blanket lien. The creditor filing a blanket lien stakes an interest to all the borrower’s assets. That could be real property, production equipment and inventory.
Unless the blanket lien excludes specific assets, the borrower may have difficulty obtaining additional credit. That’s because the business will lack collateral to back new loans.
8. Individual due diligence
Sometimes it’s necessary to perform due diligence on a person as well as a company. Owners’ or officers’ personal conduct and legal exposure may make the company less valuable, or more valuable if the owner or manager stays on as an employee or becomes a director of the purchaser.
If those circumstances apply, individual due diligence should be performed along with business due diligence.
Get answers to questions on due diligence - Contact Global Backgrounds for details on how due diligence works for you.