SMB Due Diligence: Your Ultimate Checklist for a Smooth Acquisition

Effective due diligence is crucial for ensuring a mutually beneficial agreement in SMB acquisitions. It allows buyers to thoroughly assess the seller’s financial and legal records while ensuring that the seller’s business is accurately represented. This transparency fosters a more straightforward business relationship and mitigates potential legal issues.

Despite its importance, the due diligence process for SMB acquisitions can be laborious and complex, often taking several weeks or even months to finalize. Critical elements can sometimes be overlooked, potentially leading to unsuccessful deals. It’s crucial to note that according to Bain & Company, around 60% of executives cite insufficient due diligence as a primary reason for deal failure, underscoring the significant risks involved.

Buyers often use due diligence checklists to streamline the process and ensure thoroughness. These checklists help organize document collection and ensure no important details are missed. This article will examine the essential components of a typical SMB acquisition due diligence checklist and discuss its importance in securing successful transactions.

Key Points:

• A crucial component of the SMB acquisition process is the due diligence checklist, which outlines the necessary documents the acquirer needs from the target company.
• Ensuring a successful transaction, the due diligence checklist guarantees that all vital documents are available and prepared for examination.
• Important categories to include in a due diligence checklist encompass legal, financial, intellectual property, sales, general corporate details, tax records, human resources information, property and equipment, and marketing materials.

What’s a Due Diligence Checklist, and Why is it Critical for Success?

A due diligence checklist is an essential tool used during the due diligence phase, where a buyer requests specific documents from a seller. 

This process is crucial in mergers and acquisitions, as it allows the acquiring entity to thoroughly assess the target company’s condition to determine its viability for purchase. 

Before conducting due diligence, the acquiring company compiles a checklist of documents it needs to review. This process involves identifying the key areas of the target company’s operations, understanding the specific documents that need to be reviewed in each area, and ensuring that the target company gathers all necessary information in advance. This facilitates smoother and quicker transactions that benefit both parties involved.

Essential Steps for Due Diligence in SMB Acquisitions

Let’s now take a closer look at the main stages involved in conducting due diligence for SMB acquisitions and preparing a comprehensive due diligence checklist. The process may vary slightly depending on whether the company is public or private.

Typically, the key phases of the due diligence process include:

• Addressing Initial Considerations

This phase involves identifying the type of transaction (e.g., vertical or horizontal merger), its nature (e.g., hostile takeover or friendly merger), involved parties, deadlines, and anticipated outcomes.

• Forming the Due Diligence Team

The acquiring party assembles a team of experts in various fields such as legal, real estate, intellectual property, environmental audits, human resources, and more.

• Submitting the Due Diligence Request

The acquiring party sends a due diligence request to the seller, accompanied by a detailed due diligence checklist.

• Organizing and Distributing Documentation

All necessary information for the due diligence process is gathered and structured according to the checklist requirements. This stage also includes determining the method of data sharing (e.g., via a virtual data room) and any hardware requirements.

• Collaborating on Due Diligence Findings

If needed, this involves establishing communication channels and cooperation processes between the buyer and seller during the due diligence period.

• Reviewing Essential Information Sources

At this stage, critical documents, such as SEC filings and compliance records (e.g., SOC compliance), are reviewed.

• Engaging Additional Specialists if Needed

Certain documents may require review by external experts, particularly legal documents or intellectual property assessments.

Example Due Diligence Checklist for SMB Acquisition

Before finalizing any acquisition, it is standard practice for the buyer to prepare a customized M&A due diligence checklist to guide the forthcoming assessment process. Buyers may either utilize pre-existing templates available online, such as the one provided by Smartsheet or develop a tailored checklist specific to the deal. 

Here, we provide an example of an M&A due diligence checklist to help you create your own for an upcoming transaction.

Essential Due Diligence Documents for SMB Acquisition: 8 Key Areas

When conducting due diligence, prioritize the following areas:

Essential General Information

Prospective buyers should gather key corporate records to gain a comprehensive understanding of the target company.

Organizational Documents

• Corporate organizational chart
• Articles of Incorporation and corporate governance documents
• Records on restructuring and reincorporation
• Certificate of Good Standing
• Jurisdictional authorizations
• Lists of subsidiaries, partnerships, and joint ventures
• Shareholder registry
• Agreements concerning preemptive and registration rights

Business Documentation

• Strategic business plans and board meeting materials
• Annual reports from the past three to five years
• Detailed corporate bylaws

Legal Due Diligence Documents

Companies gather specific legal, due diligence documents to mitigate litigation risks and avoid inheriting legal challenges from acquired entities.

Litigation and Legal Disputes

• Records of concluded, ongoing, pending, or threatened lawsuits involving the target company.
• Documentation of judgments, injunctions, consent decrees, and government investigations.
• Copies of all settlement agreements about the company or its subsidiaries.

Contracts and Agreements

• Documentation of the company’s contracts and agreements with consultants.
• Franchise agreements and licensing contracts.
• Copies of all guarantees issued to or by the target company.
• Indemnification agreements and any contingent liabilities.
• Correspondence from auditors and letters from corporate attorneys to auditors.

Loans and Financial Obligations

• Copies of security agreements, mortgages, letters of credit, contingent obligations, and leases.
• Records of all outstanding letters of credit and bonds.
• A comprehensive list of all banks, creditors, lenders, or guarantors associated with the target company.
• All documents related to outstanding debts, indemnification agreements, guarantees, or other financial commitments.

Financial and Accounting Due Diligence Documentation

Conducting thorough financial due diligence is crucial to ascertain the long-term profitability of acquiring a business.

Financial Records and Statements

• Comprehensive documentation of market capitalization and equity, encompassing balance sheets, stock purchase agreements, cash flow statements, and deferred revenue.
• Audited and unaudited financial statements for the past three years
• Budgetary plans encompassing both operational and capital budgets
• Copy of the general ledger detailing accounts payable and receivable
• Bank account statements for all business accounts

Control Measures and Significant Agreements

• List of internal control procedures
• Insurance coverage details
• Copies of insurance policies and audit reports
• Outline of accounting methods, including amortization and depreciation practices over the past five years
• Credit agreements, such as lines of credit and loans

Tax Documentation

• Tax structure and returns for the last three years
• Copies of tax sharing, tax benefit, and transfer pricing agreements
• Descriptions of any tax audits the target company has undergone in the past three years
• Records of property tax payments made by the target company
• Reports of governmental audits

Sales and Marketing Due Diligence Documentation

On the buy side, companies gather comprehensive sales and marketing due diligence documents to verify the target company’s ability to achieve projected profitability.

Customer Information

• Comprehensive list of current and past key customers, including revenue details
• Detailed customer analysis reports
• Copies of significant customer contracts and extended sales agreements
• Summaries and records of warranty claims

Marketing Information

• List of principal suppliers, distributors, and resellers
• Records of market research activities
• Documentation of marketing strategies, agreements, and future plans

Products and Promotional Materials

• Inventory of all current and upcoming products and services
• Collection of advertising materials such as sales sheets, press releases, brochures, and TV advertisements
• Sales performance analytics

Due Diligence in Human Resources

Conducting human resources due diligence allows for the evaluation of a target company’s primary talents and integration possibilities.

Employee Information

• Demographic overview of current employees
• Resumes of key personnel
• Details on employee benefits and manuals

HR Agreements and Policies

• Agreements on confidentiality, non-competition, and non-solicitation
• Assessments of employee skills and competencies
• Employment agreements
• Payroll records, deferred compensation plans, and pension schemes
• Policies and practices within HR
• Records of labor disputes

Intellectual Property Due Diligence Documentation

Performing a thorough review of the target company’s intellectual property helps to organize its IP assets and identify any potential issues. Key areas of focus should include:

Patents and Software

• Detailed descriptions of patents, patent applications, proprietary software, IT systems, and trade secrets
• Documentation related to patent R&D, licensing agreements, and collaborative projects
• Records of licensing income and expenditures

Ownership Details

• Comprehensive list of trade names, trademarks, and copyrights (including both registered and unregistered)
• Chain of title documentation
• Inventory of websites and social media profiles

IP Protection Details

• Documentation on IP protection strategies
• Records of claims or disputes associated with IP rights

Due Diligence for Property and Equipment

Conducting due diligence on property and equipment is crucial for ascertaining the physical assets of the target company and evaluating its acquisition value. The following documentation is recommended for review:

Property Assessments

• End-of-month and end-of-year inventory listings
• Documentation relating to inventory storage methods
• Comprehensive lists of leased and owned properties, including real estate and fixed assets, with details such as acquisition date, location, and cost

Legal Documentation

• Equipment lease agreements and property deeds
• Appraisal reports for equipment
• Uniform Commercial Code (UCC) filings

Strategic Due Diligence Documentation

Strategic due diligence provides insight into the target company’s intrinsic value and assesses the acquisition’s long-term profitability. Evaluating strategic fit is crucial to determining whether the target aligns with your organizational goals based on due diligence outcomes from various domains.

Key areas to assess include:

• Value drivers such as technology, market reach, product offerings, and intellectual property assets
• Analysis of additional costs post-acquisition
• Evaluation of potential synergies in sales, management, production, and other sectors
• Risk assessment related to the acquisition
• Examination of complementary products that enhance the buyer’s portfolio

How to Gather Due Diligence Documents

Organizations follow a systematic method for gathering due diligence documentation:

1. Negotiate Timeframes: Establish tentative deadlines for due diligence and set protocols for urgent situations.
2. Assemble Teams: Assign accountants, legal advisors, and M&A specialists to manage document collection. Each team will adhere to specific due diligence checklists covering financial, legal, marketing, and other investigative areas.
3. Gather Documentation: Work with the seller’s team, issue request lists, and compile documents in a secure virtual data room.
4. Evaluate Findings: Thoroughly review due diligence results to identify potential benefits and risks associated with the merger or acquisition.

Three Common Challenges to Watch for When Gathering Due Diligence Documents

Here are three frequent pitfalls to avoid when gathering due diligence documents.

1. Viewing document collection as a mere formality

Approximately 70-90% of mergers and acquisitions fail because buyers misjudge the advantages and risks associated with their intended acquisitions. These failures are often rooted in superficial, hurried investigations and incorrect assumptions about the businesses being acquired.

For example, Bank of America incurred losses exceeding $50 billion as a result of the imploding mortgage market and legal settlements following its acquisition of Countrywide Financial.

To prevent such issues in SMB acquisitions, it is essential to thoroughly assess and weigh the deal’s benefits and risks identified during due diligence.

While completing due diligence checklists is important, it is vital to understand that the process involves an in-depth examination of the target company rather than a straightforward audit.

2. Neglecting to Consult Industry Specialists

Relying solely on your internal compliance team, which may not have expertise in every area of due diligence, can lead to missed critical issues. Assigning document collection to general analysts increases this risk. To mitigate this, engage third-party experts to address any knowledge deficiencies within your team.

3. Overlooking Irrelevant Documents

A standardized approach to due diligence documentation doesn’t exist despite the convenience of checklist templates. These templates can guide the due diligence process and expedite it by helping you create customized checklists for your organization. With this adaptation, you can save time on documents that don’t pertain to your requirements.

SMB Acquisition Due Diligence Checklist: Ensuring Thorough Data Collection for a Successful Transaction

The SMB Acquisition due diligence checklist is designed to ensure thorough data collection and review during the due diligence process. This comprehensive approach greatly enhances the likelihood of a successful transaction. The specific items included in the checklist vary based on the nature of the deal, its goals, and the stakeholders involved. Commonly, the checklist will cover areas such as financial records, human resources information, marketing and sales documentation, tax records, legal papers, and other pertinent materials.