ThoughtStorm Strategic Capital - Thinking About Deals

Short Form Due Diligence Request List

We are often approached by small businesses that are seeking capital in connection with strategic and operational advice. For anyone corresponding with us, or frankly for anyone starting to get a handle on an existing business, here’s a short due diligence request list. This list would also serve a new director well to become acquainted with the business and its strengths and weaknesses. (We have steadily maintained that even small private businesses would benefit from outside advice, even if you don’t cede actual control to a board of directors.)

The key insight here is that the due diligence process is not the completion of the checklist. We have seen too many people gather information and fail to review it, or having reviewed it, fail to incorporate it into a transaction (investment or acquisition) plan. The due diligence process starts with a list of documents, that upon review, may trigger additional questions or information requests. One simple goal is to use the diligence process to consider the financial model underlying a proposed business transaction and illuminate the assumptions, stated and unstated, upon which the model rests.

In our framework, we look at due diligence as part of the Informed Decision-Making stage (IDM); even though the analysis of due diligence materials is part of the Data-Driven Analysis stage, the use of that analysis and its impact on the terms, structure, and price of a transaction are squarely within the IDM stage.

Here’s the list. Every transactional lawyer and banker has a vastly more detailed list, as do we. But the purpose of this list is to introduce the process to owners/founders/CEOs/directors of smaller businesses who don’t have ready access to experienced practitioners.

Copies of all historical financials for existing operations: Income Statement, Balance Sheet, and Cashflow statements.

The easiest course of action is usually to provide a "backup copy" of a QuickBooks, or other accounting program, file (with the password!). [NB: We will soon replace this requirement with a basic UFS, or unified financial statement, after we write more on that topic.]

A list of property, personal or business, that might serve as security for debt financing

Even if the owner’s desire, as one might expect, is not to encumber personal assets, many lenders are more comfortable knowing that a principal in fact has assets at risk, even if those are not security.

A current list of customers (should be in QuickBooks) and any LOI's/contracts with price and volume commitments (for existing as well as future business).
Management reports for sales rep performance and quotas for future work
Sales pipeline, backlog, or similar analysis, in the format used by management
A capitalization table, showing fully diluted capitalization
Copies of current articles/certificate of incorporation & bylaws
A current list of suppliers (should be in QuickBooks) and any LOI's/contracts with price and volume commitments (for existing as well as future business)
Other material agreements
Description of any pending litigation, whether company is plaintiff or defendant
Any audit letters from auditors if financials have been audited in last 3 years
Employment terms with employees regarding bonuses, commissions, stock options, profit-sharing, or anything material other than salary reflected in QuickBooks
Copies of all reports provided for board in the last 18 months or similar periodic management reports for the last 12 months
A description of any off-balance sheet obligations or other liabilities
A summary of any related-party transactions, individually or in the aggregate greater than $25,000

Labels: DDA, deals, due diligence, IDM

Monday, November 24, 2008 :: posted by Rick Colosimo @ 4:09 PM

Why raw data alone is insufficient for making decisions

The WSj recently published an article regarding the prospects of asking/demanding that political candidates or prospective CEOs release DNA sequence information.

For us, even though data-driven analysis is the first phase in our business leadership process (Data-Driven Analytics (DDA), Informed Decision-Making (IDM), and Intentions-Based Guidance (IBG)), it is important to understand that data alone is meaningless. While the connections between sales data and pricing strategies or marketing campaigns is at least intuitively in the ballpark for most managers, the connections between DNA sequences, genetic predispositions, health risks, and actual health problems are far more attenuated. Geneticists and doctors (since the intersection is the important issue) know that only certain DNA sequences lead to definite health problems, and that only some health problems are tied primarily to purely genetic factors. For example, Huntington's Chorea, a genetic disorder, is caused precisely by a specific gene and regularly occurs when the mutation is present. Alternatively, even if I don't have a genetic predisposition to lung cancer, if I smoke a pack a day, I'm very likely to end up in trouble.

From a business perspective, it is clear to all (well, most, since we've found some of the exceptions) that if your sales price doesn't cover your costs, you're either in for a serious economic catastrophe or an antitrust investigation. But that single accounting snapshot is not a good description of how business happens. Businesses are continually making sale after sale, at varying prices, to different customers of different products and services. Tracking the change, rate of change, and source of change across those variables can point you in the right direction. Financial snapshots are like DNA; it's possible for them to point to problems all by themselves, but most of the time, you have to analyze the system dynamically because it's a dynamic system. In science, it's called experimentation; in medicine, it's called treatment; in business, it's called management.

Labels: DDA, execution, leadership

Saturday, November 01, 2008 :: posted by Rick Colosimo @ 1:32 PM

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