Due diligence: importance, process, types and costs [incl. checklist].

Due diligence occup­ies a special positi­on in the entire M&A process. It repres­ents a compre­hen­si­ve compa­ny audit the outco­me of which will have a decisi­ve influence on the further course of the negotia­ti­ons. Although they alone do not guaran­tee the success of a Compa­ny sale can guaran­tee, it is nevert­hel­ess an important basis. So it is not surpri­sing that it is usual­ly given a lot of attention.

This artic­le explains both the formal meaning and Objec­ti­ve of the due diligence as well as the Proce­du­re in practi­ce. Last but not least, we provi­de an overview of the various Types of due diligence, inclu­ding vendor due diligence ? more on this below.

Vendor Due Diligence (VDD) is the inspec­tion of a sales object on behalf of the seller.

We also provi­de guidance for Time and Costs and the Scope in the form of a due diligence checklist.

Due Diligence Defini­ti­on: What is Due Diligence?

Due diligence is a funda­men­tal term in the M&A sector and refers to a compre­hen­si­ve review process that exami­nes all relevant aspects of a compa­ny. This process is an essen­ti­al part of transac­tion prepa­ra­ti­on and helps to identi­fy the risks and oppor­tu­ni­ties of a poten­ti­al takeover.

What does due diligence mean in German?

The English term “due diligence” is also used in this form in German-speaking count­ries, but can also be trans­la­ted as “due diligence”. Due care in traffic’ or ‘Duty of care’. trans­la­te. It is also easier to use the follo­wing formu­la­ti­on in conver­sa­ti­on ?careful exami­na­ti­on? use. The buyer thus checks all details about the compa­ny offered by the seller.

What is the aim of a due diligence audit?

In princi­ple, each due diligence can have an indivi­du­al focus. The idea of due diligence is not limit­ed to speci­fic areas. The overri­ding However, the aim is always to deter­mi­ne the oppor­tu­ni­ties and risks of an M&A transac­tion and ideal­ly to limit them.

The infor­ma­ti­on of a DD is important to decide whether a purcha­se or sale can take place at all and on what terms the Compa­ny purcha­se agree­ment is possi­ble.

Due diligence audits: Advan­ta­ges and disadvantages

In princi­ple, each due diligence can have an indivi­du­al focus. The idea of due diligence is not limit­ed to speci­fic areas. The overri­ding However, the aim is always to deter­mi­ne the oppor­tu­ni­ties and risks of an M&A transac­tion and ideal­ly to limit them.

The infor­ma­ti­on of a DD is important to decide whether a purcha­se or sale can take place at all and on what terms the Compa­ny purcha­se agree­ment is possi­ble.

Advan­ta­ges of due diligence:

  • It provi­des a compre­hen­si­ve review of a company’s or organisation’s opera­ti­ons, business model and finances.
  • It can help identi­fy poten­ti­al problems and risks (but also strengths and weakne­s­ses) that could affect the success of an M&A transaction.
  • It can help to under­stand turno­ver, costs and earnings in detail and, if neces­sa­ry, uncover content that might not other­wi­se be discovered.
  • It can provi­de certain­ty and securi­ty for both parties invol­ved in a business purchase.

Disad­van­ta­ges of due diligence:

  • It can be a costly and time-consum­ing analysis.
  • It can be diffi­cult to obtain all the infor­ma­ti­on neces­sa­ry for a thorough audit of the company.
  • It may prove diffi­cult to fully verify the accura­cy of the infor­ma­ti­on provided.
  • It can be diffi­cult to inter­pret the results and make decis­i­ons based on the test.

What is being tested?

There are no funda­men­tal restric­tions as to which documents can be inspec­ted in the course of a due diligence review. In the usual case, the buyer and his M&A consul­ting Documents provi­ded to them by the seller either in file folders or in a safe, secure and inter­net-based platform also called a data room.

In most cases, these are tax-related, Legal and finan­cial (as well as other, if appli­ca­ble) documents, records and contractswhich are checked in detail. This results in further questi­ons that the seller should answer truthful­ly. Parti­cu­lar­ly sensi­ti­ve persons, custo­mers or compa­ny data may also be neutra­li­sed and are then revea­led via a ‘key’ in the final purcha­se contract.

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What is the Due Diligence Report?

The due diligence report usual­ly consists of three main parts: a Summa­ry, a finan­cial analy­sis and an assess­ment of the poten­ti­al risks and oppor­tu­ni­tiesassocia­ted with the transac­tion. The report often also includes an analy­sis of the company’s compe­ti­ti­ve positi­on, a review of legal obliga­ti­ons and risks, and a review of manage­ment and, if available, corpo­ra­te governance.

The execu­ti­ve summa­ry provi­des an overview of the due diligence process and summa­ri­ses the conclu­si­ons of the inves­ti­ga­ti­on. It is important to note that the Summa­ry not a substi­tu­te for the full report should be considered.

The summa­ry should be suffi­ci­ent­ly detail­ed to enable readers of the report to under­stand the basic findings of the study.

In detail: What is Enhan­ced Due Diligence?

Enhan­ced due diligence (EDD) is a Important aspect of the Know Your Custo­mer (KYC) process. It is a process designed to help finan­cial insti­tu­ti­ons and other organi­sa­ti­ons identi­fy and under­stand their custo­mers and the risks they pose. It is appli­ed to transac­tions that are parti­cu­lar­ly large and relevant to an indus­try. The vast majori­ty of transac­tions do not have this scale.

It is used to assess the poten­ti­al to be used in Money launde­ring, terro­rist finan­cing and other illegal activi­ties to be invol­ved. Enhan­ced Due Diligence is a compre­hen­si­ve process that includes seven important steps. These steps are:

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  1. Identi­fi­ca­ti­on and verifi­ca­ti­on of the client
  2. Asses­sing the source of the client’s assets and funds
  3. Assess­ment of the client’s business activities
  4. Deter­mi­ne the risk profi­le of the client
  5. Inves­ti­ga­ti­on of the identi­ty of the customer
  6. Review of the client’s finan­cial information
  7. Performing a background check

Each of these steps must be taken to fully comple­te the EDD process. All due diligence steps must be comple­ted in order to proper­ly assess the client’s risk.

Due Diligence Checklist

If you would like to know which points are checked in detail, we recom­mend that you take a look at our Due Diligence Check­list to throw.

Where in the sales process does due diligence take place?

Typical­ly, due diligence is carri­ed out follo­wing the signing of the ‘Letter of Intent’. initia­ted. The LoI repres­ents a milestone in the M&A process which expres­ses a clear interest of both parties and conta­ins important elements for the subse­quent purcha­se contract.

On this basis of trust, the sensi­ti­ve documents can be released for review. Thus the Due diligence audit a crucial audit compo­nentin order to be able to present a basis for the subse­quent negotiations.

Who carri­es out due diligence?

Although both the buyer and the seller can initia­te a due diligence process, it is usual­ly the poten­ti­al buyerswho carri­es it out. The excep­ti­on is a so-called vendor due diligence (VDD) by the seller. 

Do the documents provi­ded by the seller also disclo­se all risks? In many cases, the prospec­ti­ve buyer hands over an exten­si­ve catalo­gue of questi­ons to the seller in advan­ce. The seller then prepa­res the inspec­tion of the documents.

What is not asked and has no signi­fi­cant relevan­ce does not have to be presented.

While the buyer initia­tes the due diligence, he hardly carri­es it out independent­ly from an opera­tio­nal point of view. Depen­ding on the indivi­du­al M&A use case, the a team of specia­lists is requi­red to be able to check all the documents compe­tent­ly. It so happens that Lawyers, tax advisors and also M&A advisors are used by the buyer.
Grafik zum Due Diligence Zeitpunkt
Grafik zum Due Diligence Ablauf

Due Diligence Process

While indivi­du­al exami­na­ti­on patterns can be used depen­ding on the indivi­du­al case, a 5-step model for the exami­na­ti­on process has become estab­lished in practice.

After clari­fy­ing the objec­ti­ves and focal points, a preli­mi­na­ry research is carri­ed out by the appoin­ted experts. This preli­mi­na­ry research provi­des an overview of important sub-aspects and special audit needs.

This is follo­wed by an exami­na­ti­on of the indivi­du­al sub-areas, which culmi­na­tes in a compi­la­ti­on of the results. The presen­ta­ti­on often takes the form of clear models, such as the SWOT analy­sis model (strengths, weakne­s­ses, oppor­tu­ni­ties, threats).

Recom­men­da­ti­ons for further action are derived from these results.

What are the diffe­rent types of due diligence?

Due to the diffe­rent focal points of a due diligence audit, indivi­du­al forms of due diligence have become estab­lished in practi­ce. Although they basical­ly follow similar patterns, they differ in detail.

Grafik der verschiedenen Due Diligence Arten

Tax Due Diligence (TDD)

Within the frame­work of the tax law review, the Tax situa­ti­on of the target compa­ny and its relevant tax influen­cing factors and risk factors exami­ned. At the same time, TDD struc­tures the Compa­ny sale proce­du­re in terms of the purcha­se price struc­tu­re for the buyer.

In parti­cu­lar, it is important to struc­tu­re the compa­ny acqui­si­ti­on in such a way that depre­cia­ti­on options for the purcha­se price and tax-effici­ent finan­cing are made possi­ble. And, of course, tax risks are also examined.

Techni­cal Due Diligence (TDD)

TDD exami­nes the techni­cal condi­ti­on of plants and buildings. The aim is to Evalua­te techni­cal facili­ties and buildings and identi­fy poten­ti­al for repair and moder­ni­sa­ti­on.. This analy­sis reveals, for examp­le, a hidden invest­ment backlog.

HR Due Diligence (HR DD)

Human resour­ces due diligence is a form of due diligence which A strate­gic and careful review, evalua­ti­on and analy­sis of a company’s overall human resour­ces strategy and elements. includes. The focus here is on manage­ment struc­tures, manage­ment proces­ses, human resour­ces instru­ments and systems, and corpo­ra­te culture.

Red Flag Due Diligence (RF DD)

A red flag in a DD is a signal from the buy side that can jeopar­di­se the entire M&A process. The relevant due diligence often inves­ti­ga­tes in advan­ce and quick­ly targe­ted obsta­cles for the further course of the talks. These can be, for examp­le, a proble­ma­tic finan­cial situa­ti­on or obvious errors in the documents submitted.

IT Due Diligence (ITDD)

Due to the incre­asing digita­li­sa­ti­on of many business areas, the audit of infor­ma­ti­on techno­lo­gy is becoming more important. The IT Due Diligence exami­nes the IT quali­ty and ?securi­ty as well as the future securi­ty of a compa­ny.

Environ­men­tal Due Diligence (EDD)

The EDD exami­nes the environ­men­tal quali­ty of the compa­ny, its facili­ties and buildings. Here, for examp­le, it is exami­ned with which Pollu­ti­on or inheri­ted burdens from previous indus­tri­al or techni­cal use of the compa­ny. is confron­ted with. In additi­on to this, the site is asses­sed with regard to a future protec­tion status (such as bird sanctua­ries, etc.).

Final­ly, building pollut­ants (e.g. asbes­tos in the proper­ties) are survey­ed, which can be identi­fied at Demoli­ti­on or conver­si­on work causes additio­nal costs can. Incre­asing­ly, energy effici­en­cy is becoming an important part of EDD. This area is usual­ly dealt with in conjunc­tion with techni­cal due diligence.

Commer­cial Due Diligence (CDD)

With the CDD, the Sales markets analy­sed for market share, segmen­ta­ti­on, growth and compe­ti­ti­ve situa­ti­on. In additi­on, the strengths and weakne­s­ses of the compa­ny are examined.

Commer­cial due diligence is used more in larger transac­tions. In smaller transac­tions, the acqui­rer obtains an overview of the issues exami­ned in this analy­sis during the prepa­ra­ti­on of the business plan.

Legal Due Diligence (LDD)

The LDD there­fo­re reviews all legal aspects with inter­nal and exter­nal contrac­tu­al partners of the compa­ny for legal risks and pending litigation.

For examp­le Existing tenan­cy and lease agree­ments, employee contracts, procu­re­ment and supply contracts or, for examp­le, copyright, labour law and antitrust aspects. The compa­ny was subjec­ted to a legal due diligence review.

Market Due Diligence (MDD)

Market due diligence is a process of gathe­ring, asses­sing and analy­sing market-related infor­ma­ti­on to deter­mi­ne the feasi­bi­li­ty of a poten­ti­al business opportunity.

This includes the Resear­ching and evalua­ting a target market, analy­sing compe­ti­tors’ offerings, asses­sing custo­mer needs and prefe­ren­ces as well as under­stan­ding the compe­ti­ti­ve landscape.

Finan­cial Due Diligence (FDD)

The FDD valida­tes the data used in the Business valua­ti­on infor­ma­ti­on provi­ded and analy­ses the Finan­cial oppor­tu­ni­ties and risks of the target compa­ny. This includes deter­mi­ning the sustain­ab­ly achie­va­ble income, evalua­ting cash flows as well as balan­ce sheets and annual finan­cial state­ments and checking the plausi­bi­li­ty of the business plan.

Vendor Due Diligence (VDD)

At the Vendor Due Diligence it is the seller proac­tively commis­sio­ning the audit. An indepen­dent third party is commis­sio­ned (only then is this VDD sustainable) to compre­hen­si­ve­ly audit the compa­ny in advan­ce. The results are presen­ted to the poten­ti­al buyer along with all other relevant documen­ta­ti­on. This can speed up the process and build confi­dence. However, the seller bears the higher share of the costs.

Real Estate Due Diligence (IDD)

The IDD exami­nes owner­ship and leasing relati­onships with respect to real estate that is either used for the opera­ti­on of the compa­ny or is merely counted as an asset. Condi­ti­on, obliga­ti­ons or long-term prospects of the proper­ties are only selec­ted pointswhich are exami­ned here.

3 frequent­ly asked questi­ons about due diligence

What is due diligence when buying a company?

Due diligence is a trans­la­ti­on for “due diligence exami­na­ti­on”. It is a process of resear­ching and verify­ing facts, figures and other infor­ma­ti­on related to a parti­cu­lar business transac­tion or invest­ment. It is used to reduce or elimi­na­te risk and to ensure that all relevant infor­ma­ti­on is conside­red before an agree­ment is reached.

What are the diffe­rent types of due diligence?

There are diffe­rent types of due diligence inclu­ding finan­cial due diligence, legal due diligence or even IT due diligence. Each type of due diligence invol­ves a number of diffe­rent activi­ties, inclu­ding research, analy­sis and evaluation.

How does a due diligence process work?

The due diligence process usual­ly starts with a thorough review of documents provi­ded by the compa­ny. Further research, inter­views and audits may then be conduc­ted to comple­te the full due diligence review.

About the author

Portrai Nils Koerber von KERN M&A Beratung für Unternehmensverkauf und Unternehmensnachfolge

Nils Koerber

Born in 1964, trained and studi­ed as a business­man and business econo­mist, certi­fied coach and trainer for succes­si­on proces­ses in family businesses, trained media­tor (business media­ti­on) and conflict modera­tor. Co-founder and owner of KERN - Unternehmens­nachfolge since 2004. Successful. Practi­tio­ner with many years of experi­ence in all aspects of corpo­ra­te succes­si­on in family businesses. Specia­li­sed in M&A proces­ses in medium-sized compa­nies. Learn more >