Introduction:

Due Diligence is the verification process of information and its associated documentation to ensure a reasonable individual "that they get what they are paying for". When buying, selling or forming a joint venture it is very important that the books and records are verified and tested to ensure the historical financial results are validated. If your company has a team of professionals who have experience in multiple transactions and a detailed checklist to follow that is probably an exception to the rule, most companies due these type of transaction infrequently. Therefore, it is recommended that due diligence be a coordinated effort with members of the company and an outside firm who has experience with the due diligence process.

The following are examples of questions to ask during the interview of key management staff when following the due diligence checklist.

QUESTIONS FOR VP OF MANUFACTURING

Manufacturing/Operations

o What work is done at each location (manufacturing, assembly, distribution)?
o How would you describe operation flow (job shop, assembly line)?
o Is manufacturing in your industry moving to Asia?
o Which plants perform best/worst?
o What is current capacity utilization at each location?
o Is there overcapacity in the industry?
o Any quality issues in the plant?
o Any other operating issues?
o How big is the average job (small or big relative to industry)?
o Do competitors have higher or lower costs than the company?
o Does the company pay overtime? What is the rate?
o Is any sort of certification required to operate in industry (FAA, FCC, etc.)?
o How many shifts does the company run?
- How many hours per shift?
- What is capacity utilization at each plant (based on 7 or 5 days)?
o Does the company have a valuable patent/other intangible?
o Are there immediate needs for the purchase of new equipment?
o What are the most pressing issues facing the manufacturing department of the company?
o Manufacturing Process
- Describe operational flow? Do you have a diagram of the company's process?
- Where are the bottlenecks in the system?
- What are the areas with excess capacity?
- Have there been any changes to the operational flow recently?
- What is the scrap rate by product line?
- Has productivity declined?
- How are jobs costed?
- How are jobs scheduled in the plant?
- How much setup time is required for each changeover?
- What is mix between big jobs and small jobs?
o What is the lead-time required to make purchases for production of goods?
o Do you think there is an opportunity to increase prices to any customers?
o Any other operating issues?
o Over what period of time does the company depreciate its various kinds of equipment?
o Has the depreciation time frame changed recently?

Machinery

o What is the machinery?
o Over what period of time do you depreciate the equipment?
o What is the average useful life of the equipment?
o Do you have an appraisal?
o Are there any assets in the company that need to be written down to fair market value?
o Is there a market for the machinery in the US?
o Is there overcapacity in the industry? If so, this could hinder the sale of the equipment.
o Have there been recent big sales of equipment in the market (large bankruptcy or liquidation)?
o What is the book value of the equipment (net and gross)?
o Where is the machinery located?
- Is the facility owned? If not, do you have a landlord's waiver?
o How much of your equipment is leased vs. owned?
o On average how old is the machinery?
o Does the newer equipment tend to be leased?
o What are needed capital expenditures in the near future?
o What have been capital expenditures in the past?
o What is the maintenance level of capital expenditures?
o Have there been recent large capital expenditures?
o How much capital expenditures have been delayed due to cash flow issues?
o Is there any excess M&E the company is not currently utilizing? If yes, whom could it be sold to?

QUESTIONS FOR VP OF MANUFACTURING OR CFO

Real Estate (owner occupied)

o What real estate does the company own?
o Where is it located?
o How old is the property?
o How many SQF is the property?
o How is the SQF divided between office, manufacturing, warehouse, other?
o Are there any environmental issues and potential hazards?
o Are any major renovations necessary (roof)?
o Any major renovations or additions to the facility recently?
o Plans to expand or contract facilities?
o When was it purchased and for how much?
o Have similar properties sold recently and for how much?
o What is the price/Square Feet in this market?
o Do you have a recent appraisal or Broke Prepared Opinion?
o What is the assessed value of the property?
o Is the building for a specialized use?
o How much debt encumbers the properties?
o What are the terms of that debt (term, rate, lender, debt service)?
o Are there any statutory or judicial liens on the property: mechanic's liens, judgment liens, tax liens, etc.?
o What entity owns the property?
o Who owns that entity?
o Do you have any tenants?
o Does the lender have an assignment of rents and leases?
o Are the leases at market rate?
o What are the terms of the lease?
- Rent
- Term
- Use of premises
- Right of assignment and sublease
- Option to buy
- Default
- Termination
o Are you current on real estate taxes?
o Is the bank requiring escrow payments for taxes, insurance, etc?
o Are there any deed restrictions on the property?

Conclusion:

The due diligence process is very financially oriented, but professionals in legal, tax, human resources, insurance & risk, sales and operations are typically involved in the process and responsible for difference areas of the validation process. Do not take the process lightly and do not assume the information being provided is correct without a through vetting and analysis to validate the accuracy.

It takes an experienced, cross functional team to perform due diligence, remember this is also part of the negotiation process as the final purchase price usually is adjusted based on the information from due diligence. Be sure to ask the right questions, then validate!