Preventive Law Pro Tips: The Due Diligence Checklist

“I’m making a list of things I must say . . .”
 Shel Silverstein

Acquiring or merging with another business can be an exciting time. However, it is imperative that you take ample opportunity to look under the hood of your new target . . . but where to begin?

To keep things focused and organized, start with a checklist of information and documents to request from the other side. Keep in mind, inundating your target with a 20+ page list of items down to the minutia may be counterproductive in many instances (unless the transaction is complex enough that the target should be expecting such a list). Instead, consider starting with broad strokes, narrowing the inquiries as necessary based on potential red flags uncovered.

As an initial matter, since quite a bit of sensitive business, financial, marketing and intellectual property information and material will likely be exchanged between the parties during the diligence process, there should be a Non-Disclosure and Confidentiality Agreement negotiated and signed in advance. If you will be providing your own confidential information and documents as part of the evaluation, make sure any such agreement is mutual.

Dear Santa . . .

Below is a starting point with items to request as you begin your inquiry. Seek the help of a Preventive Lawyer to guide you throughout the process. Remember, being proactive can keep you from acquiring a lemon.

1.     Organizational/Qualification Documents

A red flag should always go up if your business target has not followed appropriate formalities. After setting up business entities, owners are generally required to proactively govern that entity from the initial documentation all the way through growth and global domination. These formalities exist not only in the home state but also in any other state in which the company has operations.

And depending on the type of entity structure and number of business owners, there may also need to be written rules or agreements governing the actions of the owners themselves, as well as minutes, consents and resolutions which can tell the history of your target’s business. Don’t get blindsided by compliance landmines or exposure from silent owners who could disrupt your enjoyment of the acquisition or merger after closing.

2.     Financial Documents

It should go without saying that your target’s financial performance is important. Don’t rely on what you’re being told by your counterpart’s owners, but instead get copies of records that you can audit yourself to determine performance. And don’t be satisfied with just one year of prior records. You’ll want to go further back to track any trends (hint, asking for up to five years of returns and financial statements is typically not unreasonable).

Now would be a good time to mention that you should have a seasoned accountant or other financial expert on the diligence team to provide guidance as to any pitfalls which may exist in those records.

3.     Agreements

A company’s contracts and agreements with third parties are often the lifeblood of its business (and they may be a primary reason why you’re so interested in this particular target in the first place).

Review these agreements to ensure you won’t be assuming onerous, impossible or impractical obligations. You’ll also want to know whether any one-sided language exists that could limit your opportunities to recover in the event of a breach. You may find that those contracts you liked so much aren’t as attractive as you once thought.

In addition to the business contracts, be sure to review agreements potentially affecting your target’s real estate (hint, this will be particularly important if you are acquiring real estate and improvements as part of the transaction). And, of course, it is important to know whether your target has been appropriately insured.

4.     Licenses/Permits

Depending on the industry involved, your target’s business may require certain federal, state or municipal licenses or permits. Better to know now whether your target is appropriately licensed or permitted and, if so, whether those are current.

5.     Assets

Your target’s contracts may not be the only shiny things attractive to you. Its assets may likewise be a key driver to your interest in the acquisition or merger. Make sure to request a list of information and documents related to these assets to independently confirm that you’ll actually be receiving the assets you are expecting to receive as part of this transaction.

6.     Liabilities

What would assets be without liabilities? Naturally, this is the next section, as you need to know whether there are any obligations, claims, lawsuits, investigations, etc. that could blindside you. These can often be deal-breakers, so be sure to uncover everything involving these red flags up front.

7.     Employee Information/Documents

Turning back to your target’s business practices, learn about the individuals employed by the business. Request information on how many people your target employs, their cost of employment, and which employees are critical during a transition period for continued operation (just in case you were considering “synergies” or down-sizing immediately after closing the transaction).

In addition, get copies of your target’s internal employment policies and practices, including the employee handbook and any specific work-related policies that may not necessarily be included in the handbook (hint, some of these, like work safety policies, may be more relevant when merging with or acquiring a manufacturing target with productions lines).

8.     Customer Problems/Negative Publicity

Brand and goodwill may be important considerations in your acquisition or merger, particularly if the target is a product manufacturer. Request information related to any customer problems or negative publicity if this is an item of importance.

Keep in mind the above is a general starting framework. Your industry may necessitate beefing up one or more of the sections up front . . . or even adding new sections entirely. As an example, if you are acquiring a medical device or pharmaceutical target, you’ll want to know the extent of any market corrective actions and product recalls. This could mean expanding Section 8, as well as Section 6 since corrective actions/recalls may also equal claims and lawsuits (hint, you may consider adding an entire new section on your target’s regulatory practices to investigate compliance on that front).

As responsive information and documents start rolling in, you can decide whether you have enough information to satisfy concerns related to a specific subject. Or, should red flags emerge, you can request supplemental information and documents to aid in chasing rabbits down holes until you get the answers you need. The ultimate goal is to make an informed business decision related to your target . . . so get the information to do so!

Preventive Lawyers are skilled at working with your team to request and gather the appropriate information and material needed to investigate an acquisition or merger target. And they can then analyze this information and identify potential issues of concern warranting further investigation or consideration.

In sum, engaging a good Preventive Lawyer to take a look under the hood will help ensure you’re not acquiring a really expensive lemon.

KEEFER is your ounce of prevention.

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