What is Management Due Diligence?
Management due diligence is the process of reviewing and assessing a company, either for the purpose of acquiring it or to better assess their value. It requires an in depth understanding and analysis of the company’s financial structure, operations, legal history and other relevant areas. As observed by Fintalent’s management due diligence consultants, small companies are at risk from fraudsters as well as from large companies who may want to buy them outright.
The main goal of performing a financial due diligence is to assess the financial health of a company. It is an analytical procedure, which involves thorough examination and verification, on the part of the buyer, of the financial statements, busi-ness plan and any business projections prepared by the seller or management. The analysis also involves a similar examination by the parties to determine if there will be any problems after closing.
Any business that is up for sale will have certain strengths and weaknesses with respect to its finances and business structure. By performing this assessment, potential buyers can identify any weak areas that need correction before proceeding with offers or negotiating terms.
Managers should conduct Managing Due Diligence in order to understand:
- The business needs for which they are responsible
- Information about competitors
- Opportunities for improvement or other improvements
- To meet their requirement of managing risk management and mitigate “risk before it happens”.
- To ensure they are making sound decisions based on the facts and information available to them.
There are three main objectives of Management Due Diligence:
- To understand all aspects of the business that may have an impact on its success
- Evaluate the environment and identify risks
- Identify opportunities to improve performance in both the short-term and long-term
The results of due diligence can be used as a management tool for decision-making by identifying weaknesses that need to be addressed for future success (e.g., operational gaps or other issues) or by providing identification of strengths that should be maintained and fixed from any potential threats (e.g., competitive intelligence).
Due diligence for an acquisition is a process that most companies undertake before purchasing a business. This process allows the buyer to make sure that the business they are purchasing is worth the price being offered by investigating the strengths and weaknesses of the business, as well as its operations, competitors and customers. Due diligence is typically conducted by an organization’s management and legal teams, but could be conducted by a third party, such as an investment bank or law firm. Due diligence may be limited to “process”, operational due diligence or a more detailed “financial” due diligence.
Conducting a management due diligence helps companies to make informed business decisions by identifying any issues or risks, as well as opportunities for the future. It is usually part of a wider process known as corporate risk management and may include conducting, for example, a financial business review or risk assessment. Management due diligences help companies be proactive in dealing with possible issues before they develop into problems. This supports the creation of an environment that encourages proactive behavior and reduces the likelihood of individuals making hasty decisions(e.g., quitting their jobs with no alternatives).
When conducting a management due diligence, it is important to ensure that critical information is obtained.
Ways to ensure critical information is obtained
Typically, the first step in a management due diligence is an informal discussion with the current owner or manager of the business as they provide some background information regarding their company. In this initial meeting, the buyer’s team will discuss their goals and expectations for instance needs to improve operational efficiencies, reduce operating costs, and increase product sales. They will also review the financial status of the company and assess possible risks related to the purchase. If a deal is reached and the company is purchased, it will allow the buyer to examine the operations of the business. Once this process has been completed, it may reveal that the current owner or manager has not been completely honest about their business.
The second step in conducting a management due diligence is to complete a review of existing policies and procedures and evaluate how they are implemented and functioning. This will allow the buyer to understand how each department works individually as well as how they function collectively. This includes an examination of operational processes including: Accounting, Sales & Marketing, Human Resources, Sales & Service Support, Operations & Production and IT (Information Technology).
The third step in conducting a management due diligence is to conduct a formal financial due diligence. This is the process of verifying an individual’s financial position and that he/she has a sufficient capital base to run the business. It will also determine the value of their assets and liabilities. At this stage, it is important that everyone involved in the purchase are aware of each other’s financial position (e.g., corporations, banks, etc.) so that there are no surprises at tax time or when making financial decisions in regards to company expenditures or cash flows. If a deal is reached and the company is purchased, it will allow the buyer to examine the financial status of the company. Once this process has been completed, it may reveal that either: The existing manager or owner under reported their liabilities or they over estimated their assets.
The fourth step in conducting a management due diligence is to review any contracts and agreements which may be related to certain policies, procedures and operations. This may include examining or negotiating purchase of new equipment, contracts with suppliers, suppliers’ guarantees and warranties.
The fifth step in conducting a management due diligence is to evaluate the performance of key personnel by reviewing formal evaluations and interviewing them to determine issues or problems they may be having. This step is usually conducted through discussions with colleagues, team members, subordinates and managers. Shortcomings should be discussed and documented with key personnel and improvement plans should be developed for all areas which are lacking.
Based on the results of your Management Due Diligence, you can take Corrective Action Plan to fix any problem you found.
