Due Diligence

Due diligence is the integral part of any financial transaction, be that acquisition, merger or merely an investment. In fact, every time you invest in a stock, you should conduct basic due diligence process.

Due diligence is the process, fundamental to any investment. It is also a reality test -- whether the deal you are involved in is worth it. The person, actually several of them most of the time, conducts a thorough legal, financial and strategic investigation of the company's documents, operating history, contractual relationships and organizational structure. "Mergers and Acquisitions from A to Z" by Andrew J. Sherman (ISBN 081440376X) is a great source of the basics of the due diligence process.

The key to a successful deal ultimately lies with good due diligence process. The person should not conduct the process with the objective in mind. If you do, then you fail automatically. If you are looking for bad stuff -- you will find it. If you are looking for only good stuff -- you will neglect the bad one. Given a sufficiently large context one can find anything he/she wants. You can find a prophecy of Bill Clinton/Monica Lewinsky affair in the Bible if you try really hard!

It is not the task of the person who is doing the research to make a judgement. His purpose is to present all the information "plain vanilla", so that the dealmaker makes that judgement.

Here is a sample list of due diligence items one should be looking for:

Due Diligence Overview


I. Background / General
A. Brief review of organization and operating history
B. Provide a description of major products or services offered
C. Short-term and long-term operating strategy
D. Discuss vulnerability of the current strategy to the economic cycle, regulatory changes, variances in the Company’s competitive situation, and industry trends
E. Provide current business plan
F. Provide corporate organizational chart

II. Financial Performance
A. Audited financial statements (last 5 years)
B. Review of financial history by division (last 5 years)
C. Review of interim financial results by division
D. Quarterly financials (last 3 years)
E. Projected monthly budget by division (1 year)
F. Review of actual versus budgeted results (last 3 years)
G. Outline fixed versus variable expenses
H. Detail historical growth (visual aid)
I. Research & development expenditures (last 3 years)
J. Discuss seasonality of business and impact on working capital needs
K. Plans for future financing arrangements
L. Inventory analysis by product line

IV. Customers/Contracts/Programs/Products
A. Revenue and EBITDA/profit for major customers/contracts/programs/products (last 3 years)
B. Customer/contract/program/product concentrations
C. Total revenue for top 10 (last 3 years)Total EBITDA/margin for top 10 (last 3 years)
D. Major customers/contracts/programs/products gained or lost (last 3 years)
E. Discuss any contracts performing at a loss
F. Revenue by international vs. domestic
G. Discuss pricing dynamics and trends

V. Industry / Competition
A. Discuss current industry specific trends and how these trends affect the Company/programs
B. Discuss Company’s market share in each market segment
C. List primary competitors by division or market segment and their respective market share
D. List Company’s strengths, weaknesses, opportunities, and threats

VI. Marketing
A. Outline strategy for each product line or division
B. Outline sales/marketing coverage model
C. Current and historical market research/customer surveys

VII. Ownership Structure
A. Current ownership structure
B. Reasoning for current management’s desire to divest/sell the business
C. Share repurchase strategy

VIII. Management
A. Review any recent management changes
B. Overview of management stock ownership and incentive programs
C. Summary biographies of officers and directors

IX. Employees
A. Provide number of employees and if possible their functional breakdown
B. Outline incentive compensation
C. Discuss use of workers to address seasonal demand

X. Technology
A. Assess impact of technology changes on business
B. Discuss Company’s technology/engineering capabilities
C. Discuss current research & development programs
D. Review any material patents and/or trademarks currently held or pending

XI. Manufacturing
A. Describe manufacturing process for each product line
B. Describe present usage of facilities and equipment
C. Summary of quality assurance programs/procedures

XII. Suppliers
A. Discuss relationships with primary suppliers
B. Supplier volumes and degree of concentration
C. Total purchases from top 10 suppliers by product category (last 3 years)
D. Major suppliers gained or lost (last 3 years)
E. Discuss material prices, pricing dynamics, and trends

XIII. Accounting Methods
A. Summary of significant accounting policies (including industry specific nuances)
B. Discussion of internal accounting controls
C. Review any adjustments required for GAAP
D. Outline revenue recognition methodology
E. Outline pension funding policy

XIV. Other Items
A. Review of environmental issues

Back again.

It is not that easy to write a blog, actually, it is not easy keep up with it. I finished my Actuarial Exam FM on May 26th and now it is June 14th. Let me catch up.

The exam went well, surprisingly well. I finished it in 1.5 hours out of two and had time to go over. (actually, as I was going over it I came a cross one problem that I skipped. Solving it, took another 20 minutes!!!!)

There is a very useful and very illegal thing, which is done by some people on the forum I frequent. It is called PAK, or Popular Answer Key. Society of Actuaries prohibits exam takers from taking the exam results from the examination room, but people program the answers into their calculators, so that they can participate in PAK. The name is self explanatory, the answer that was the most popular among the candidates is considered to be correct for any given question. People who usually compile PAK also include the probability of any given answer being correct.

Anyways, I got 22/25 correct according to PAK!!! Later that week the Society released the exam with the preliminary answers (the real result will be available on July 6th) -- and again I got 22/25. Should I be happy yet???

That same day, after the exam, I started my internship full time, after going to the bar (at noon!) alone!



Ever since then, I have been here, on the 37th floor in First Canadian Place, downtown Toronto, with occasional outings to see my girlfriend and sleep (weekends not included, thank God!!!). It has been just over two weeks and I have learned a bunch already, be that due diligence, legal statements, RTOs, accounting statements, transaction processes etc. Been to one shareholders' meeting, ate at a restaurant on their account and generally met tons of people, expanding my network of connections, which will come in handy when looking for full-time employment next year.

A bit later I will write a post about due diligence, for now, back to work...