Due diligence
Due diligence is the stage in the assessment process when your advisers check you and your business out. It is carried out in a formal way by advisers preparing your business for flotation, or by venture capitalists. Other investors, like business angels, will do checks on a less formal basis. Due diligence allows these advisers to verify that your business is in a fit state to go to the public markets, has sufficient potential to attract the interest of investors, and is strong enough to withstand the rigours of being a publicly-quoted company.
It involves a detailed investigation by your financial advisers into your company and its plans. As part of the process the adviser thoroughly examines:
- the business's structure, how it is owned and constituted, and the necessary changes prior to taking the company to the market;
- the business's financial health, based on a detailed examination of past financial statements and an analysis of the existing asset base;
- the credibility of the business's owners, directors and senior managers, including validation of the career histories of all the main players in the business;
- the future potential of the business, reflected in the strengths of its products and the probability of earnings growth over the medium to long-term;
- an assessment of the risk involved in your business in terms of your markets, your strategy and likely future events; and
- the company's business plan, in terms of how realistic it is, how solid the assumptions are and how well it conveys your business's potential.
Most of the work is carried out by professional staff from your firm of financial advisers. Outside experts may be drafted in to cover particular aspects of the assessment, to verify legal documentation or to look at specialist areas. For instance, if your company's products are innovative or specialised, industry experts may be brought in to comment on the market potential for your business. If the business is involved in high-tech, this specialist analysis may be a significant part of the due diligence work carried out.
The process
Due diligence is usually carried out after you have made an in-principle commitment to proceed with your advisers, and is completed before the production of the prospectus and other documentation involved in the flotation. The agreement reached with your advisers should specify how much due diligence is to be carried out and should estimate how much it is going to cost.
The level of due diligence required will greatly depend on the nature of your business and what you're looking for from investors. Generally speaking, the amount of due diligence work will depend on a number of factors, such as the newness of your company to the market and your reasons for floating the company and the stock market you are selling your shares through.
The importance of due diligence
If it is an extensive assessment, it can be very time-consuming, and seem to divert from the real task of taking your company to the market. Equally as it is carried out by highly-paid professionals, it may appear to be very expensive, accounting for a significant part of the cost of coming to the market. However, due diligence is in many ways a central part of securing finance or floating on a public market. It is through this process that your adviser validates your business, its past track record, the credentials of its existing owners, managers and directors, and the potential represented by its future plans. The process is also used to decide the price to pitch your shares at, and who to pitch the shares to.