In the world of business, the phrase “Don’t take a chance on a deal before you’ve completed your due diligence” is frequently repeated. It’s true: The pitfalls of not performing thorough due diligence on the company and valuation could be catastrophic both financially and for reputational reasons.
Due diligence is the process of examining all the information that buyers need to make an informed decision about whether or not to buy a company. Due diligence also helps identify potential risks and serves as the foundation for capturing value in the long term.
Financial due diligence checks the accuracy of a potential company’s income statements and balance sheets, as well as cash flows, as well as assessing pertinent footnotes. This includes identifying assets that are not recorded and liabilities, as well as overstated revenue that could negatively impact the value of a business.
Operational due diligence, in contrast is focused on a business’s capability to function independently of its parent company. AaronRichards examines a company’s ability to increase the size of its operations and improve the performance of its supply chain and increase capacity utilization.
Management and Leadership – This is a key part of the due diligence process because it shows the importance of current owners to the success of the company. If the company was established by a family member, for instance, it’s important to determine if there’s any hostility or an unwillingness to sell.
Investors look at the long-term value of a company during the valuation phase of due diligence. There are a variety of methods to evaluate this, and it’s crucial that the method of valuation is selected with care based on the size of the company and the kind of industry being assessed.