Due Diligence Checklist: Pre, During & Post Deal Steps Explained

Due diligence is the backbone of the entire M&A process since it unearths all pertinent information. That is why misleading data remains among the most challenging hurdles in the M&A process.

Therefore, it is essential to have a comprehensive due diligence checklist in place to ensure the process does not miss or overlook vital information.

Below is a guide that walks you through the types of due diligence and the stages it undergoes, along with a comprehensive checklist of vital components.

TL;DR – Complete Due Diligence Checklist

You can break down the due diligence checklist into three major categories:

• Pre-Deal: Define objectives, scope, and timeline; assemble a cross-functional team; establish a data room and perform high-level risk screening.
• During Deal: Perform financial, legal, operational, tax, HR, IT, commercial, and IP reviews. Validate records, interview management, and quantify liabilities and opportunities.
• Post-Deal: Finalize integration plan, implement retention incentives, and set and monitor KPIs.

This snapshot only outlines the checklist items. To truly understand how to conduct comprehensive due diligence, continue reading.

What Is Due Diligence and Why It Matters

Due diligence is the process of ascertaining the actual state of a target business or asset before initiating a business transaction. It aims to verify facts, uncover risks, and validate assumptions before finalizing a merger or acquisition.

Simply put, due diligence matters because it converts uncertainty into a calculated risk by:

• Authenticating financial statements.
• Uncovering liabilities and potential legal exposures.
• Determining fair market value.
• Verifying revenue drivers.
• Vetting operational structures.
• Counterchecking tax and regulatory compliance.
• Reducing potentially costly surprises.
• Identifying potential growth drives post-transaction.

Types of Due Diligence Processes

Due diligence processes evaluate various aspects of a business during major transactions, including mergers and acquisitions. These processes fall into either the hard or soft due diligence categories.

Hard due diligence assesses quantifiable aspects, such as financial statements, while soft due diligence assesses qualitative factors, including organizational culture.

Below are several forms a due diligence process can take:

1. Financial Due Diligence: Analyzes financial statements, accounting policies, financial projections, working capital, cash flows, and debt agreements.
2. Legal Due Diligence: Reviews corporate formation documents, contracts, litigation records, regulatory compliance, material agreements, and indemnities.
3. Intellectual Property Due Diligence: Evaluates ownership, registration status, licensing terms, and potential infringement risks of IP assets like trademarks, copyrights, and patents.
4. Tax Due Diligence: Checks past tax filings and audits, tax planning policies, deferred tax liabilities, and possible avenues for reducing tax obligations.
5. Operational Due Diligence: Compares output to production capacity, evaluates supply chain and logistical resilience, and inventory management systems.
6. Human Resources Due Diligence: Reviews compensation structures, employment contracts, benefit plans, staff turnover, and existing or potential labor disputes.
7. Cultural Due Diligence: Compares the organizational cultures of the companies involved and identifies potential compatibility issues that may arise after the transaction.
8. Commercial Due Diligence: Evaluates market size, market positioning, customer base, competitive advantages, and disadvantages.
9. IT Due Diligence: Inspects system architecture, software licensing agreements, data protection measures, disaster recovery, and security posture.
10. Environmental, Social, and Governance (ESG) Due Diligence: Investigates ecological liabilities and compliance issues, permits, sustainability practices, and governance structures.

Key Components of a Due Diligence Checklist

Given the complex nature of the deal process, it is advisable to create a checklist that serves as a roadmap for the entire due diligence process. A checklist ensures those involved in the due diligence process do not just view it as a formality but as part of a greater strategy.

So, what should your due diligence checklist entail? Let’s have a look.

Corporate Structure and Records

This phase begins with the verification of incorporation documents, like articles of incorporation and certificates of good standing.

• It also highlights past changes to the company’s legal structure, to confirm legal existence and capitalization.
• Next, the evaluation of the ownership and equity structure follows to determine the type of shares on offer and their share class rights, as well as outstanding stock options and existing dilution processes.
• This phase also includes reviewing governance documents, such as board meeting minutes, internal memos, and resolutions, which are crucial for identifying outstanding governance issues. It helps the buyer understand the legal identity and governance frameworks that control decision-making processes.

Financial Statements

The objective of financial due diligence is to determine the accuracy and reliability of the target’s financial data and identify potential risks and opportunities. Accountants and financial advisors should have an interest in:

• Historical Financials: Review at least the past three to five years of audited and unaudited income statements and cash flow statements to establish trends in revenue, margins, and cash generation.
• Working Capital and Cash Flow: Review accounts receivable and accounts payable, inventory turnover, and cash conversion cycles to assess operating liquidity and identify seasonal fluctuations.
• Financial Forecasts and Budgets: Ensure the target company’s economic projections and funds allocated to all ongoing and future projects are reasonable and align with past financial statements.

Tax Compliance

Tax compliance reviews identify risks that could impact the deal’s valuation or lead to penalties. The checks include:

• Tax Filings and Audits: Check filings across relevant jurisdictions, including federal, provincial (in Canada), state (in the US), local, and foreign levels over the past five years.
• Correspondence with Tax Authorities: Ascertain historical tax positions, review previous settlement documents, and determine whether there are open audits.
• Tax Planning Measures: Identify potential exposures to unnecessary tax obligations, scheduled assessments, and audits.
• Deferred Tax Positions: Assessing deferred tax assets and liabilities clarifies potential future tax issues.

Legal Matters, Litigation, and Exposure

Legal due diligence exposes potential legal risks, liabilities, and obligations. Legal experts often review the following categories:

• Pending and Threatened Litigation: This includes complaints, judgments, matters in arbitration, and settlement agreements, which the buyer may view as potentially contingent liabilities that can pose reputational risks and materially affect value.
• Regulatory Compliance: Overviews existing and pending licences, permits, and industry-specific regulatory filings, and highlights historical compliance issues to identify legal constraints and remediation obligations.

Material Contracts

One of the more tedious stages of the due diligence checklist is the material contracts process that reviews the company’s contractual agreements and commitments. The buyer should thoroughly go through:

• Supplier Contracts: Review pricing parameters, delivery schedules, exclusivity agreements, termination clauses, and contract renewal provisions to understand the level of supplier dependency.
• Customer Contracts: Identify top customer contracts, pricing terms, termination parameters, supply or service demands, and renewal provisions.
• Real Estate Agreements: Evaluate property ownership versus lease obligations, rent escalation clauses, and sublease rights that affect long-term cost structures and relocation risks.
• Distribution Agreements: Understand exclusivity agreements, territory definitions, areas of operation, termination triggers, and minimum purchase commitments to determine market access and market flexibility.

Human Resources

The target company’s human resource policies and talent retention efforts can differ significantly from those of the buyer. Therefore, human resource due diligence is required to find hidden liabilities and smoother integration efforts after the acquisition. The following aspects should be under review:

• Employee Roster: Review the complete list of employees to understand the organizational leadership structure, the key responsibilities of every departmental manager, and reporting policies.
• Employee Contracts: Review compensation policies, benefits, pending offer letters, non-compete and confidentiality agreements to identify hidden liabilities and retention challenges.
• Incentive Plans: Analyze the incentives offered to employees, particularly senior management, such as stock options and performance shares, and review their vesting schedules to understand how they will impact post-transaction dilution and retention costs.
• Labor Relations: Review the target company’s history of labor strikes, existing union agreements, and collective bargaining terms, then analyze the company’s compliance with local employment laws to indicate potential labor disruptions.

IT Systems and Data Security

IT due diligence identifies vulnerabilities and threats that could impact operations and lead to the loss of sensitive information. It also determines whether systems are secure and compliant with data regulations. Some areas of focus include:

• IT Systems: Ideally, the IT infrastructure, like servers, databases, hardware, software, and networks, should be compatible with the acquiring company’s IT systems.
• Cybersecurity: Review existing data security protocols and incident history, and analyze encryption standards to quantify potential threats, breach risks, and regulatory exposure.
• Software Licensing Agreements: Review all software licensing terms to determine adherence to licensing agreements, ongoing costs, and potential IP conflicts.

Operations and Supply Chain

Operational efficiency and scalability are vital for growth. As such, operational due diligence evaluates overreliance issues, constraints, and risks that could stall integration efforts. Areas of interest include:

• Manufacturing and Production: Review plant capacities, maintenance records, and product quality reports to identify operational strengths and weaknesses, as well as potential scaling opportunities.
• Inventory Management: Identify fast-moving and slow-moving stock, as well as backlog orders, and ensure production equipment is in working condition.
• Logistics: Identify major suppliers, calculate lead times, and review contracts to ensure the target’s supply chain is resilient and cost-effective.
• Health and Safety Protocols: Analyze the health and safety protocols, as well as levels of regulatory compliance, to ensure necessary employee protections are in place.

For more information on key components of the due diligence checklist, do not hesitate to contact us at JS CPA Strategic Solutions.

Step-by-Step Process to Conduct Due Diligence

Due diligence is a thorough process that demands meticulous attention to detail. Although the process may vary from one transaction to another, all the steps fall into three main phases: pre-deal, during-deal, and post-deal.

Below is a step-by-step guide on conducting due diligence during each phase.

Pre-Deal Phase

The pre-deal phase lays the foundation for initiating the due diligence process.

It involves involving a team to carry out the process, setting goals, and obtaining information from the other parties, among other tasks, such as:

1. Outline Due Diligence Objectives: Define the scope and duration of the process, identify key areas of interest, and develop critical questions.
2. Setting Up the Due Diligence Team: Identify the professionals who will conduct the process, like accountants and lawyers, and then appoint project leads.
3. Gather Information: Request all relevant documents for the process and index all documents received from the seller. Establish a secure data room that requires login access.
4. Initial Information Review: Conduct a rapid financial, legal, and operational review to create a comprehensive picture of the company’s actual position. Identify red flags and fatal flaws that would be immediate deal breakers.

During-Deal Phase

The during-deal phase carries the most workload. It involves carrying out in-depth investigations on any conceivable type of due diligence in the following steps:

5. In-depth Review: Evaluate the information provided in greater detail to assess factors such as customer satisfaction, financial well-being, operational practices, and other relevant aspects.
6. Draft the Due Diligence Report: Present the negotiating team with an executive summary of the process that highlights key areas of interest and concern.
7. Seek Clarifications: Meet with the other team to address areas of concern and request any necessary clarifications.

Post-Deal Phase

The post-deal phase focuses on the future and highlights ways to ensure the merger or acquisition is successful. Steps to follow include:

8. Planning for Integration: Highlight ways in which you can retain talent, maximize productivity, and set KPIs.
9. Consolidate the Findings: Compile a comprehensive report that verifies all findings from the process. It should include a list of risks and opportunities that will impact valuations and future operations.

The due diligence process can seem complex and confusing, especially for first-time buyers and sellers. You don’t want to risk undertaking a surface-level check only to end up on the short end of the stick.

JS CPA Strategic Solutions helps businesses struggling with exit readiness gaps prepare for mergers or acquisitions by ensuring that all necessary documents, primarily financial, legal, and tax compliance, are in order.

Go to the negotiation table with a strong position of leverage. Book your exit readiness consultation today!

Common Mistakes to Avoid During Due Diligence

You can make numerous mistakes during the due diligence process. Some of the most common ones are:

• Rushing the Process: Rushing the review and analysis of crucial information can lead to costly oversights. It is vital to take your time and analyse all data systematically.
• Over-Reliance on Seller-Provided Information: Many buyers instantly trust the information provided by the seller, which can result in being duped. It is crucial to have an independent data verification system to countercheck the seller’s information.
• Failure to Engage Experts: It’s easy to assume the M&A process is straightforward and conduct your own due diligence, which can result in missing details pertinent to the deal. As such, involving certified and experienced professionals when conducting legal, financial, and IT reviews is necessary.
• Ignoring Cultural Fit: Failing to consider significant cultural differences can hinder integration efforts and compromise employee retention. Therefore, it is essential to examine all internal workplace dynamics to ensure they align with your company’s culture.
• Setting Aside a Structured Checklist: Another mistake is conducting haphazard due diligence, lacking a clear sense of direction, because a checklist is not used. Failing to follow a checklist can result in missing crucial steps. Therefore, it is essential to establish a due diligence checklist at an early stage.

To avoid such pitfalls and ensure a smoother transaction and long-term success, visit JS CPA Strategic Solutions.

Sample Due Diligence Checklist Template

Here is an example of a checklist you can use during the due diligence process:

Checklist Category	Items to Review	Done	Pending
Corporate Structure	Articles of incorporation
	Certificates of good standing
	Ownership structure and shareholding
	Board meeting minutes
Financial Statements	Audited and unaudited income statements
	Balance sheets
	Cash flow statements
	Accounts payable
	Accounts receivable
	Financial projections
Tax Compliance	Federal tax filings
	State tax filings (USA)
	Local tax filings
	Provincial tax filings (Canada)
	Deferred tax assets and liabilities
Legal	Contracts and settlements
	Licences and permits
	Trademarks, copyrights, and patents
	Litigation history
Materials	Supply contracts
	Customer contracts
	Property ownership deeds
	Lease agreements
	Distribution agreements
Human Resources	Employee list
	Employee contracts and benefits
	Non-competes and Confidentiality Agreements
	Labor Agreements
IT Systems	Hardware and software inventory
	Databases, Servers, and Networks
	Security protocols
	Software licensing agreements
Operations	Plant capacity
	Maintenance records
	Inventory
	Production equipment
	Health and safety protocols

Frequently Asked Questions (FAQs)

Below are answers to various questions about due diligence that we have received from past clients.

What Is the Difference Between Due Diligence and an Audit?

Due diligence is a comprehensive investigation intended to inform negotiations, assess risks, and facilitate integration planning during a transaction.

Conversely, an audit is an independent, formal, periodic assessment, focused on ensuring that financial statements are accurate and comply with accounting standards.

Who Is Responsible for Conducting Due Diligence?

The buyer or investor carries primary responsibility for conducting due diligence and typically assembles a cross-functional team of experts, including lawyers, financial advisors, tax consultants, IT and cybersecurity specialists, and industry consultants. Sellers often provide only the required documents and facilitate access to them.

How Long Does a Due Diligence Process Typically Take?

Due diligence timelines can range anywhere from a few weeks to several months. This is due to the varying complexity and size of the deals. Small acquisitions often take two to six weeks, while mid-market deals typically require four to eight weeks, and large or cross-border mergers can take more than three months to complete.

How Much Does Due Diligence Usually Cost?

Due diligence usually costs anywhere from $10,000 to $250,000 or more. The total cost depends on various factors, including scope, geography, and specialized requirements.

Conclusion

A due diligence checklist is a must-have tool for both buyers and sellers. It helps you calculate value, expose cracks in financial, legal, and operational statements, and help chart a path forward after the deal closes.

Consequently, you want the due diligence process to be as thorough as possible to unearth any underlying issues that could hurt your post-deal operations.

Unfortunately, many companies lack the internal resources to conduct comprehensive due diligence, making it a valid reason to partner with an M&A advisory agency.

JS CPA Strategic Solutions has nearly a decade of experience conducting due diligence for buyers or sellers looking to acquire (or exit) their businesses. We also assist our clients with deal structuring and negotiations to ensure you obtain the best possible deal.

Schedule a personalized call today to start the due diligence process.