Buyout Book : Excerpt

Excerpts  ::   Glossary of Banker Speak  ::  Chapter 1

Due Diligence Checklist

Due diligence is a tool a manager or individulat can use when reviewing different facets of the business they are interested in acquiring. This is a generic list that needs to be tailored to meet the individual specifics of any given opportunity.

Industry and Company Overview
Industry Classification

  1. Client definition/Form 10-K
  2. Business section of prospectuses
  3. Trade association publications/data
  4. Manufacturing process or principal areas of value added
  5. Production—sales cycle
  6. Customer profile
  7. SIC code
  8. Security analysts’ reports

Growth Trends and Prospects; Size and Profitability of Other Firms in Each Industry Segment

  1. Industry’s performance and trends
    1. Industry’s historical performance
      1. Rate of increase in sales and earnings
      2. Market share growth, primary and secondary demand
      3. Consistency among companies
      4. Comparison of the industry’s performance with that of other industries
      5. Comparison of the company’s performance with that of its industry
      6. Determination of the cause of any company variations
      7. Financial market acceptance, including credit ratings
    2. Stability of companies within industry
      1. Turnover of competitors
      2. Volatility of earnings and access to financial markets
      3. Credit ratings changes
      4. Mergers, acquisitions, and consolidations
      5. Bankruptcies and reorganization
    3. Trends within industry and potential impact upon the company’s future operations. Examples of such trends include:
      1. Scarcity of raw materials
      2. New regulations
      3. Shift in product mix or demand
      4. Increase or erosion in profit margins
      5. Increased competition or demand from abroad
  2. Structure of competition in the industry
    1. >Industry structure
    2. Identity of principal competitors and share of market
      1. The company’s market share and position within the industry
      2. Elements of competition
        1. Price
        2. Quality and features
        3. Delivery or service
        4. Engineering
        5. Advertising
      3. Shifts of competitive structure within the industry
        1. Market share changes
        2. Price reductions
        3. Extended credit terms
        4. Producing and holding merchandise
    3. Susceptibility to changes in economic environment
      1. Product substitution or alternatives potential
      2. Cost/price relationships
      3. Predominant suppliers
      4. Likelihood of forward or backward integration
  3. Industry Business Characteristics
    1. Research and development
      1. Dependence on R&D and technology
      2. Product or process successes by others
      3. The company’s success compared to competitors
      4. Importance of patents and cases of infringement
      5. Rate of R&D expenditures compared to norm
      6. Potential obsolescence due to:
        1. New equipment or processes
        2. Technology
        3. Products
    2. Marketing and distribution
      1. Method of distribution and control of these channels
      2. Advertising or promotional expenditures
      3. Margin structure throughout the distribution chain
    3. Manufacturing process
    4. Labor relations
      1. Organization status
      2. Strike history
      3. Wage and benefit trends
      4. Availability and skill level
    5. Seasonality or cyclicality of industry

Company’s Relative Position in the Industry

  1. Relative sales and earnings levels and growth rates
  2. Market shares and positions
  3. Company strengths and weaknesses vis-à-vis relevant competitive factors in the industry
  4. Company’s geographic coverage and customer type
    1. Analyze stability
    2. Demographic trends
  5. Reputation and product recognition

Major Individual Products and Product Lines

  1. Sales—unit and dollar volume
    1. Five-year historical and current interim figures
    2. Projections
      1. Management
      2. Independent industry analysts
    3. Product catalog and price list
  2. Quality and feature comparisons
  3. Pricing
    1. Seasonality or cyclicality
    2. History of discounting and price reductions
    3. Ability to pass along cost increases
    4. Preferred customer discounts
  4. Product life cycle
    1. Pending obsolescence due to:
      1. New equipment or processes
      2. New products
      3. Underlying demand or demographic shift
  5. Seasonality or cyclicality of product demand
  6. Substitutes and complementary products

Product Development

  1. Resources and requirements as compared to the industry
  2. Historical and projected R & D expenditures
  3. Feasible studies on marketing and production (i.e., is the technology marketable?)
  4. Patents
    a. Licensing agreements
    b. Actual or potential cases of infringement


  1. Profit contribution by product line
    1. Five-year historical and current interim figures
    2. Projections
      1. Management
      2. Independent industry analysts
  2. Stability and consistency of earnings
  3. Earnings growth
    1. Acquisitions
    2. Internal growth

Demand and Customer Analysis
List of Major Customers

  1. Industry position of customers
  2. Dollar size of sales
  3. Customer turnover and loyalty
  4. Domestic vs. international breakdown

Purchase Decision

  1. Price
  2. Quality/features
  3. Engineering
  4. Customer decision process
  5. Brand and trademarks (i.e., are the company’s name and trademark well known?)

Marketing Focus (e.g., advertising, packaging, delivery)

  1. Advertising
    1. Expenditure relative to industry
    2. Importance to marketing strategy
  2. Design and packaging
  3. Discounting
  4. Trade shows
  5. Customer contact method
  6. Marketing expense

Marketing Staff

  1. List and evaluate
  2. Structure of incentive system
  3. Branch offices, warehouses, service facilities<


  1. In-house capability
    1. Transportation
    2. Order processing
  2. Retail operations
    1. Layout
    2. Number of locations and their geographic distribution
  3. Dependence on outside channels
    1. Flexibility of distribution channe
    2. Margins along distribution chain

Description of Processes

  1. Nature of manufacturing processes
    1. Batch or line process
    2. Labor or capital intensive
    3. Wage structure and demands
      1. Unionization and history of labor relations
      2. Recent or pending strike activity
    4. Abundance, age, and educational level of workforce
    5. Licenses or patents
  2. Inventory control
    a. Breakdown by finished goods, work in process, and raw materials
    b. Warehousing
  3. Flow of materials and plant efficiency (and compared to industry)
  4. Quality control
  5. Maintenance procedure and expense
  6. Hazards and insurance
  7. Internal vs. outside services for various production stages

Raw Materials and Other Inputs

  1. Cost
    1. Trends and variability
      1. Extent of substitutability
      2. Ability to pass-through cost increases
  2. Competition for and control of supply
    1. Same industry vs. outside
    2. Major suppliers
      1. Contracts
      2. Financial condition of suppliers (particularly foreign)
      3. Dependability
    3. Purchasing arrangements
  3. Subcontractors for parts or subassemblies

Facilities and Equipment

  1. Condition and age
    1. Planned capital expenditures
    2. Capacity utilization
      1. Historical
      2. Planned
    3. Facilities
      1. Owned vs. leased facilities
      2. General-use or specialized capacity
      3. Factors preventing capacity expansion
        1. Zoning
        2. Production process
        3. Access
  2. Maintenance expense
    1. Expected replacement near term
    2. Expected replacement long term
  3. Power, water, and waste disposal
    1. Availability
    2. Adequacy

Material and Pending Litigation

  1. Potential exposure
    1. Consequences to operations
    2. Consequences to financial condition
  2. Insurance

Accounting Responsibility and Function
Quality and Size of Financial, Accounting, and Internal Audit Staff—Reporting System

  1. Size of internal financial staff
  2. Do they have/ require internal auditors?
  3. Review internal audit reports

Existence of Ongoing Records

  1. Description
  2. Equipment used to keep records
  3. Accuracy of interim financials

Differences between Book and Tax Records
Budgeting System

  1. Integration of costing and financial records
  2. Analysis of costing system
  3. Replacement cost accounting

Frequency and Adequacy of Physical Counts

  1. Review with external auditors

Variations in Company’s Accounting Policies from Industry Norms

  1. Revenue recognition
  2. Inventory
  3. Replacement cost accounting
  4. Depreciation
  5. Treatment of foreign exchange gains or losses

Credit Control Procedures

  1. Any recent changes in customer credit procedures?
  2. Review credit manuals.


  1. Status of audits
  2. Accountants’ management letter
    1. Suggested improvements
    2. Formal reviews and changes during last five years

SEC or FASB Opinions or Payments

  1. Pooling issues
  2. Revenue recognition

1. Review pertinent policies

Cost Accounting

  1. Major elements
  2. Overhead history
  3. Allocation


  1. Returns and allowances
  2. Recognition of income—sale or delivery
    1. Installment sales
    2. Affiliates
  3. Intercompany sales and profits
  4. Consolidation policies

Profitability Forecast

  1. Factors most likely to affect estimates
  2. Change in financing structure and effect on profits
  3. Overhead or corporate expense

Other Sources of Income

  1. Royalties
  2. Rents

Treatment of Minority Interest

Asset Management

  1. Inventory valuation and reserve structure
  2. Breakdown work-in-progress, raw materials, and finished goods


  1. Aging schedule
  2. Bad debt allowance


  1. Identification
  2. Valuation

Other Assets

  1. Notes receivable
  2. Intangible assets
  3. Identification
  4. Amortization

Fixed Assets

  1. Book value
  2. Replacement cost
  3. Original cost and/or adjustments for purchase accounting
  4. Potential write-offs
  5. Depreciation
    1. Average life
    2. Type of depreciation
      1. Book vs. tax
    3. Accelerated to account for obsolescence
  6. List of properties

Current Liabilities

  1. Credit by major vendors
  2. Discounts received or lost
  3. Provisions for outstanding liabilities and contingencies

Other Liabilities

  1. Penalties
  2. Litigation
  3. Additional taxes
  4. Contingent
  5. Pension funding items

Capital Structure
Long-Term Debt

  1. Amount outstanding
  2. Rates
  3. Maturity—prepayment provisions and penalties
  4. Debt ratings
  5. Covenants
    1. Coverage—interest, fixed charges, assets
    2. Principle repayments
    3. Ratio requirements
  6. Convertibility
  7. Events of default

Short-Term Debt—Lines of Credit

  1. Interest expenses during start-up
  2. Availability and draw-down
    1. Current
    2. Historical
    3. Cost

Lease Obligations

  1. Capital leases
  2. Operating leases

Preferred or Hybrid Securities

  1. Review documents
  2. Redemption features
  3. Change of control provisions

Shareowners’ Equity

  1. Paid-in
  2. Retained earnings
  3. Treasury stock

Cash Flow
Working Capital Requirement

  1. Relationship among inventories, receivables, and payables
  2. Minimum cash required to run business
  3. Ability to convert nonproductive assets into cash for working capital

Capital Expenditures

  1. Desired
  2. Required

Depreciation and Amortization

  1. Adequacy of estimated useful life of equipment being written off
  2. Goodwill


  1. Deferred taxes: revenue recognition, depreciation
  2. Reserves for prior year’s taxes
  3. States in which returns are filed
  4. Treatment and availability of investment tax credit
  5. Availability of Net Operating Losses (NOL)
  6. Allocation
  7. Foreign vs. domestic
  8. Puerto Rico

Dividend Policy and Restrictions

  1. Dividend policy
  2. Dividend restrictions

List Key Personnel—Salaries and Titles

  1. Turnover and experience
  2. Depth of management
  3. Recruiting and training
  4. Affiliations


  1. Wage scale, promotion, and review
  2. Employee contracts and service agreements
  3. Incentive awards (e.g., stock options plans, earn-outs)
  4. Insurance (life and medical), autos, personal loans, and vacations
  5. Deferred

Board of Directors

  1. Age and service
  2. Other directorships and affiliations
  3. Meetings—review frequency and substance
  4. List of committees and assignments
  5. Insider or related-party transactions

Security Issues

  1. Rights of each class
  2. Stock options
  3. Stockholder agreements


  1. Principal holders of various classes
  2. Geographic distribution
  3. Institutions
  4. Unidentified

Securities Convertible into Common and Major Holders Thereof

Industrial Relations

  1. Number of employees
  2. Source of labor
  3. Skilled vs. unskilled

Competition for Labor

  1. Turnover
  2. Ability to vary workforce


  1. History of strikes
  2. Next scheduled bargaining

Work Conditions

  1. Accident frequency
  2. Last OSHA review
  3. Morale—grievances and suits
  4. Wage scale and promotion review and policies

Compensation and Benefits

  1. Compensation structure
    1. Frequency
    2. Overtime
    3. Profit sharing
    4. Vacations and holidays
    5. Guarantees and indemnities
  2. Pension plan
    1. Level of benefits
    2. Extent of funding of accrued pension benefits
      1. Unfunded past service liability
      2. History of expenditures
    3. Last revision
    4. Transferability
    5. Effect on profitability
  3. Life insurance and medical benefits

Document Checklist

  1. List of Participants (business and home address, phone number, facsimile number)
    1. Client team
    2. Investor team
    3. Attorneys
    4. Accountants
    5. Lenders
    6. Other involved parties
  2. Financials
    1. 10K—audited last five years
    2. 10Q—unaudited stub period
    3. Annual reports
    4. Registration statements (filed or pending?)
    5. 8K reports on recent unscheduled material events or corporate changes
    6. Five-year plan with assumptions
    7. Historical budgets
    8. Policy manual
    9. Proxies
    10. Accountant letters
    11. Pension plans including latest actuarial evaluation
    12. Filings unique to industry (e.g., bank call reports, insurance convention blanks)
  3. Product Lines
    1. Sales and earnings reports
    2. Price lists
    3. Market size and share estimates
  4. Industry Publications
  5. Legal Documents
    1. Articles of incorporation and bylaws
    2. Domicile of major operations (name and address of subsidiaries)
    3. Indenture agreements
    4. Corporate history
      1. Name changes
      2. Ownership structure
      3. Acquisitions
    5. Patents, trademarks, and copyrights
    6. Licensing agreements
      1. Distribution
      2. Technology
      3. Franchises
      4. Royalty agreements—basis, expiration, renewal, and cancellation
    7. Government contracts
    8. Noncompete restrictions
    9. Warranty and service agreements
    10. Assets pledged or notes cosigned
    11. Litigation or suits in progress or pending
    12. Relationship with financial and business community
      1. Institutional lenders
      2. Investment bankers
      3. Analysts and broker presentations
    13. Union contracts