Key Considerations in Corporate Due Diligence for Mergers & Acquisitions

Without due diligence, any money on the table would inevitably go to the seller. Buyer’s always have a duty to shareholders to ensure no rock is left unearthed when it comes time to prepare the business for divestment and sale. In software mergers it is of particular importance as many key considerations with the software itself can be swept under the rug. Sifting through and picking out current and potential issues is always key in balancing a strategic acquisition in a particular niche endeavor. Here are a few considerations.

  • Intellectual property. Are there any IP issues which could block the company from practicing or fully utilizing the potential of any technological breakthrough? If so, are there any work-around options?
  • Human resources. Consideration should be given on all HR issues, including HR handbooks and guidelines.
  • Legal risks of commercialization. This can go as broad and as deep as the ocean and is highly dependent on other issues unearthed during due diligence.
  • Long-term product integrity. Is the business one that is sustainable? Is there a profit sancuary and is the product robust enough to
  • Development issues. What types of code and/or development issues or hurdles remain? If some exist, is there a plan and timeline for their completion?
  • Integration of third-party IP. If third party IP is required for the business to be sustainable, what are the legal and financial liabilities of making external IP work within the confines of the business?
  • In-person interviews of software developers. This is always helpful and could create a separate list
  • Third party patent clearance study. In some instances having a third-party patent attorney look over potential IP issues will be absolutely necessary. Better to pay a little up front rather than getting slapped with a huge lawsuit down the road.
  • Inbound/outbound license agreements. Depending on how services flow, there are often expenses with inbound and outbound software license agreements. Knowing the process can sometimes open up many other questions. It is essential due diligence questions be asked on pricing as well as processes.
  • Source-code escrow release agreements. What about the source-code? How will it be transferred in the event of divestiture? How is it currently being transferred via employees and contractors?
  • Potential unwritten side deals. Are there other deals, offers, freebies, giveaways or agreements which are outside the scope of what the company initially represented? If so, what is outstanding?
  • Company articles of incorporation and corporate bylaws. These are generally pretty boiler-plate, but will be helpful in determining
  • List of pending and/or threatened lawsuits against the company. Get the dirty laundry out and shake it out.

Due diligence on company employees:

  • Existing employment issues
  • Golden parachute
  • General current and potential retention and compensation issues
  • Non-compete covenants
  • Stay bonuses
  • New employment recommendations

Financial due diligence:

  • Annual financial statements for five years (income statement, balance sheet, cash flow statements)
  • Reconciliation of federal tax returns to annual income for preceding five years
  • List of annual sales by product category including category, revenue and gross margin
  • List of annual revenue by marketing channel
  • List of standard product lines including regularly stocked items along with the most recent cost per unit

The more knowledge the deal team has on the target company’s industry, the better equipped deal makers will be when it comes time to enter negotiation proceedings. This list is just preliminary, but is helpful in brainstorming due diligence questions which may arise as you attempt to buy or sell a business.

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Nate Nead
Nate Nead is a licensed investment banker and Principal at Deal Capital Partners, LLC which includes InvestmentBank.com and Crowdfund.co. Nate works works with middle-market corporate clients looking to acquire, sell, divest or raise growth capital from qualified buyers and institutional investors. He is the chief evangelist of the company's growing digital investment banking platform. Reliance Worldwide Investments, LLC a member of FINRA and SIPC and registered with the SEC and MSRB. Nate resides in Seattle, Washington.
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