Green Flags vs. Red Flags: Understanding the Due Diligence Process

Selling your business is likely the most significant event that you will ever face. You worked relentlessly to achieve success, and obviously, you will want to get the highest sale value possible. This means that you should be completely prepared for buyers to conduct thorough due diligence on your company, and you should be ready to perform due diligence on a potential buyer.

By conducting thorough due diligence before taking your company to market, you will be prepared for a buyer to complete their own due diligence process smoothly. The more prepared you are, the more valuable your business will appear to buyers. 

In the execution of mergers and acquisitions, the due diligence process is crucial to closing a successful deal for several reasons. The process involves several key components, each requiring meticulous attention to detail to ensure that neither buyer nor seller is surprised.

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Proper due diligence involves a thorough examination of every area of a business. In each of these areas, you want every single item to check out as a green flag, which means there are no problems, missing information, or shady arrangements. This includes:

• Financial analysis – Trading activities

–   Year-end accounts

–   Management accounts

–   Forecasts

–   Sales

–   Customers

–   Suppliers

–   Sub-contractors

–   Employees

• Financial analysis – Assets and liabilities

–   Balance sheet

–   Premises

–   Operating assets

–   Intellectual property

–   Stock & work-in-progress

–   Trade debtors

–   Cash and equivalents

–   Trade creditors

–   Other creditors

–   Loans and overdraft

–   Intercompany loans

–   Taxes

–   IT

• Legal

–   Shareholders and directors

–   Constitutional matters

–   Guarantees

–   Contracts

–   Legal commitments regarding capital expenditures

–   Premises

–   Insurance

–   Legal disputes

–   Environment

–   Health and safety

–   Systems

–   Misc. agreements

But what about red flags in the due diligence process? These are some issues to look out for:

• Poor cash flow 
• A need for significant capital investment
• Supply chain issues 
• Irregularities or discrepancies within financial documents that can point to poor record keeping, financial instability, or even fraud
• Missing financial data
• Dependency on a small number of large clients
• Unresolved tax liabilities 
• No access to capital
• Poor market share position
• Legal and compliance disputes
• Overvalued reported assets
• High levels of debt
• Lack of effective marketing strategies
• High employee turnover, which can signify management or cultural issues
• Environmental noncompliance with regulations
• Antiquated workflow systems 
• Intellectual property issues 
• Outdated technology or product offerings
• Inadequate management
• Research and development issues
• Unfunded liabilities 
• Cultural issues that impact staff morale
• Product liability claims
• Conflicts of interest 
• Complicated corporate structure 
• Lack of business strategy or vision
• Recent or impending regulatory changes 
• Contract expiration or transferability issues 
• Insufficient insurance coverage 
• High levels of old, useless inventory
• Absence of disaster recovery plans 
• Noncompliance with industry standards 

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Due diligence is crucial to any M&A transaction. Being properly prepared before a sale can position a business to gain higher valuations, better negotiations, and the best possible outcomes. Investing time into thorough due diligence processes early in a transaction will prevent unwelcome surprises and potential liabilities for both buyers and sellers alike. If you suspect you have any of these red flags in your business’s background, you will want to take measures to immediately address them before trying to sell your business.

Yes, it sounds like a lot of work, because it is. Ensuring that there are none of these red flags as early as possible in the due diligence process is key to a successful M&A transaction. But you don’t have to do it all on your own. Our experts at Benchmark International leave no stone unturned when conducting due diligence for our clients, ensuring that the process is fully transparent and comprehensive. We want to provide you with the most value in a sale and help you achieve all your aspirations.

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