Preliminary due diligence

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JP Bio PhotoDr. John Psarouthakis, Executive Editor, Founder and former CEO, JP Industries, Inc, a Fortune 500 industrial corporation. Adjanct professor, Strategy and Acquisitions, Ross School of Management, University of Michigan

This is the 6th of short articles of my thoughts about Acquisition of a business.

This brief article reviews the important step of preliminary due diligence that takes place once a confidentiality agreement is signed and you are satisfied that the acquisition prospect meets your major criteria. The preliminary due diligence has three important aspects, a meeting with the seller, one or two company visits and a preliminary review of documentation. There are four key goals in the preliminary due diligence phase. They are:

  1. To determine whether this company is what you want to buy (barring any unexpected “skeletons” you might uncover during formal due diligence) ?
  2. To determine price you want to offer in your letter of intent
  3. To determine whether the seller is serious about selling and why
  4. To develop rapport with the seller

There is a variety of information that you can gather at this stage, without spending a lot of money, by reviewing available documentation and visiting the company. During preliminary due diligence, you want to get an overall sense of the company’s financial condition, marketing and sales, employee practices, manufacturing processes, and, very important but sometimes overlooked, environmental issues. Basically, you inherit any potential liabilities that are buried in the information that the seller provides. And if the seller lacks deep pockets, you can still be sued for problems that you inherited but did not cause. The earlier you surface those skeletons, if they are there, the less time you waste on a company that is perhaps best to pass over.

You also carry out preliminary due diligence to get a more accurate estimate of the price you plan to offer, to make sure that you and the seller are not too far apart.

The next step picks up where this one leaves off, with the drafting of a letter of intent and formal due diligence.

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