Due Diligence – Houston Law Firm
Due diligence can be defined as the investigation of a product, potential investment or a company to confirm all the facts that give a clear understanding of it. It involves reviewing of the financial records and material and confirmation of all the important facts. This article by RunRex.com is meant to discuss the important steps to be followed when conducting due diligence.
- Company capitalization
The capitalization of a company helps in the formation of a mental picture of the company. It also allows you to gain an understanding of the volatility of the stock, the broadness of the ownership and the size of the end markets of the company. In this stage, no judgments should be made. This stage is meant to set the stage for the entire due diligence process. It is merely the first step of obtaining all the necessary information about the company of interest.
- Financial trends
This is the point where one begins to analyze the numbers the company of interest is dealing with. The main financial aspects that are considered at this stage include the revenue, company profits, and the margin trends. Have a look at the company’s detailed net income and revenue trends in the past two or three years. Look at how the company has been performing quarterly and obtain an overall impression of how the company performs regarding their revenue. Also, have a look at their profits. From this analysis, determine whether the margins are rising, remaining at constant or falling.
- Competition
A review of the company’s finances will give you an insight on how big the company is, and a look at the business model can help you get an idea of how business is conducted and how money is generated. What follows is to have a look at the industries that the company operates in and the level of competition that is available in that environment. You can get information about the competitors by simply conducting a simple research online. Getting to know the competitors can help you gain a better understanding of how your target company operates and its overall performance in the market in relation to size compared to their competitors.
- Company management and its share ownership
This basically involves a review of the management of the company. Inquire about the organizational and managerial changes that have characterized the company and how often the same has happened. The age of the company is a huge determining factor here. A fairly young company has a high likelihood of still being run by the founding members while the older ones may have undergone organizational and managerial changes over time.
If the top managers have high ownership stake in the company, that is a plus. On the flip side, a company whose top managers have little ownership raises alarms.
- Assessment of company’s assets and liabilities
Have a look at a consolidated balance sheet of the company to see liabilities and assets of the company. Pay special attention to the company’s ability to pay the short-term liabilities and any long-term debt that the company currently has. In case you find that the company has a fairly large debt, that should not be a cause of major concern. However, if the company’s financial position is not strong and points to the company being in debt for extensively long periods, then that should be a cause for concern.
- History of the company stock price, stock options, and dilution possibilities
Have a look at the long-term company stock trends. The company’s stock history will give an understanding of the profits that the company has been experiencing and what the experience of an average stock owner has been. Short-term shareholders characterize stocks that tend to be continually volatile.
The company’s quarterly SEC filings give a picture of the stock options and the conversion expectations. This information can help you understand the changes you would expect in the company’s share count given different price scenarios.
- Understanding the risks
While you have to consider the risks at the initial stage before profiling a business, it is important to analyze the possible risks that come with you investing, merging or acquiring the company. Ensure that you have a full understanding of the company-specific and the industry-wide risks involved. Consider any regulatory and legal matters that may arise, how eco-friendly the company is and any long-term risks. When considering a merger, acquisition or just investment, always have the healthy devil’s advocate active and going by ensuring that you exhaustively look at the worst-case scenarios and their potential impact on the company.
These are just the main steps that are to be followed to gain a deeper understanding of the company of interest. These steps help get a clear understanding of the business which will help you make an informed decision on whether to invest, merge or acquire the company or whether you should consider another candidate.