Checking Into an

Acquisition Candidate
TABLE OF CONTENTS

Page

1. GENERAL BACKGROUND ............................................

Background...........................................................................2
Market Position and Strategy................................................3
Management and Human Resources.....................................4
Operations.............................................................................4
Financial................................................................................4
Other......................................................................................4
Transaction............................................................................5

2. PRODUCT LINES, MARKETS,

INDUSTRY CONDITIONS AND COMPETITION..........................................7
Demand.................................................................................8
Market Segmentations...........................................................9
Sales Performance................................................................10
Product Lines........................................................................10
Marketing.............................................................................11
Industry Conditions and COinpeutiOil.......................................12

3. OPERATIONS............................................................................................15
Plant and Facilities................................................................17
Production............................................................................18
Materials Management.........................................................20
Inventories and Costing........................................................22

4. HUMAN RESOURCES......................................................................................25

s. oncecosmEanrio s ......................................................... 31
Financial Data......................................................................................32
Balance Sheet Review...........................................................................34
Financing and Capital Structure ........ ,....................................37
Stand-Alone Considerations...............................................................39
Prospective Financial Information...........................................................40
Financial Management..........................................................................41
Electronic Data Processing (EDP)....................................................43
Risk Management.................................................................................... 44
Taxes.....................................................................................46
TABLE OF CONTENTS

Pagi

6. MANAGEMENT STYLES AND PRACTICES................................................. 51

Management Approach ........... ,............................................52
Planning................................................................................53
Internal Controls .. ....... ... ............ ,.........................54

7. RESEARCH, DEVELOPMENT AND ENGINEERING............................57

8. LEGAL MATTERS........................................................................................61

9. ENVIRONMENTAL ISSUES........................................................................63

10. THE TRANSACTION MODEL ..............

INTRODUCTION

What does this book do for me?

We have designed this book to help you conduct successful due diligence. We use the same version
ourselves and have found it beneficial when assisting both Buyers and Sellers and as a general analytic
tool to monitor business performance. This introduction is designed to offer some thoughts on how to
structure a successful due diligence program and to highlight some of the common pitfalls.

The book is a tool to provoke thought, but it is not a substitute for careful planning. Nor is it a
standard program or manual. We believe that a standard approach to due diligence is meaningless
because each transaction is different, as are the participants. We therefore recommend that you use the
book as a reference guide to tailor your inquiries, rather than simply starting on page one and working
through each question. A completed checklist will not guarantee success, more likely, just a headache!

H do ou ructu e successfu due d 1 •e ce ro•

By way of introduction, we thought it would be useful to include a guide to the due diligence process
itself. Outlined below is a basic structure and some of the common issues we regularly encounter. For
the basic structure, we suggest the following components:

1. Understand why you are doing due diligence.

2. Establish a plan for the process (the team, scope and timetable).

3. Separate your critical issues from the wish list.

4. Translate your findings into value (price and terms).

5. Plan for the transition.

In summary, stay focused. Too often, we see situations which reflect a lack of planning and direction.
Participants become inflexible and are confused by both the detail of information and speed of the
transaction. The approach and findings are piecemeal and lack insight. Internal politics interfere with
the objectives. Negotiations then focus on issues that are not critical. And it all fails.

The five-point structure above is designed to help you stay focused. Let's therefore address each in
greater detail:

1. Whv do due dili•qence?

Before beginning the due diligence process, you need to understand "the why"’ Why are you doing
due diligence? This focus needs to be kept in mind throughout. Too often, ”the why" gets lost in
the excitement of the "deal". We saw one perfectly sound deal collapse because a key manager
suddenly realized that he would have to relocate overseas to lead the operation. Thereafter, every
issue became an insurmountable problem for him and the transaction fell apart. In another
situation, we saw the Seller obtain vital last-minute concessions because the Buyer's team had
 instructions to complete the deal without knowing "the why." They yielded value because of
inadequate lmowledge of the Buyer's deal drivers.

We can separate "The Why" into three broad categories:

• Buyer Beware: The Seller is entitled to package the product to maximum

advantage. This is not calculated to deceive a Buyer, but is part of the commonly
accepted selling/negotiation process; akin to your buying a house. You inspect the
goods to ensure that they satisfy your understanding and expectations. After all,
the term "rustic charm" in the real estate community can have several
interpretations, not all of which might be attractive to you. Use due diligence to
confirm your understanding of what you are buying.

• Assume But Control Risk: As a Buyer, you will assume some risk. It is rare that
a purchase contract can permanently eliminate all risk. First, it would be a difficult
and expensive legal and negotiating process and second, the Seller would probably
not acquiesce. The Buyer therefore assumes some risk, but attempts to control the
amount by obtaining detailed knowledge in advance of closing. The tool is due
diligence.

• Identify Opportunity: The Seller may not have identified the magnitude of the
potential opportunity, either because the Seller does not know the Buyer's business
or appreciate its own value — creating opportunities. We see examples of this
frequently: a bloated cost structure; an uncooperative worMorce; a technological
innovation; a marketing strategy; adequate financing; and appropriate motivation
all provide real opportunity. Use the due diligence process to confirm your
thoughts or to identify opportunity.

Although these three broad categories are useful as a framework, you must translate "the why"
into your own situation. Why are you actually buying or selling? Is it to obtain market share,
technology, people, systems, synergy, earnings, liquidity, cash flow or other attributes? Also, do
you need to consider an exit strategy (a future sale, public offering or recapitalization)? These
factors should drive the scope and extent of your due diligence, as we discuss further below.
Value each of the attributes and be prepared to measure them against changing facts and
circumstances. More simply, expect bad news from the due diligence process and evaluate it
against "the why". Dont be distracted by the events, timing and complexity of the transaction.

You may find Section 1 of the book particularly useful as you establish "the why." It's preparatory
material.

2. Establish a Process Plan

Having established "the why," you need to plan the process. Careful planning will save time,
money and bring focus to your strategy and decisions. The process plan should be flexible
because fâcts and circumstances change, but "the why" should remain the mission statement.

What does a process plan look like and what's in it? Of course, there is no standard answer
and your own culture should be the driving force. We have seen planning sessions that
resemble
 military briefings for a commando assault, complete with briefing maps and targets. Other
situations are so muddled that a riot would seem organized by comparison. The first style can
restrict initiative while the latter can cause the team to miss key issues.

The format depends on your own particular style and strengths. However, we recommend that
your process plan contain at least the following steps:

• A timetable (with start, finish and interim steps, such as the timing and location of
'‘ progress meetings, negotiations, signing, etc.).

• The team; who is on it and what are their responsibilities.

• The process of communication, both internal and external (who to contact, when,
what can and cannot be discussed, etc.).

• The project scope; what will be done, and any areas of specific interest or concern
to be addressed.

• The method for reporting findings (to your team, the negotiating group and the
other side).

• Responsibility for post-transaction integration.

Some tips on the above:

• Be realistic about your timetable. No one wants to be the first to admit

' that the timetable cannot be achieved. Help your team by offering
flexibility and suggesting alternatives. Focus on the objective, not the
process.

• Remember that deals are rarely completed within the original timetable.

• Consider who will have to give approval to complete the transaction.

What will they require? (Remember to evaluate both internal and
external groups, boards, departmental structures, bankers, etc., and the
presentation formau expected. )

• Use external professionals to benchmark your own analysis against

current trends in the business or transaction cycle. Professionals should
not be a substitute for your own work - you are likely to know your own
business better than they. Seek professionals with industry knowledge,
 recent transaction experience, resources and most importantly, an
objective view.

• Make sure that your team regularly shares in collective knowledge. It

minimizes duplication. Also, one team member's observation can affect
several areas of ñiquiry.

• The process of communication

• A key part of due diligence is to identify "deal breakers" early and to

communicate them to the team.

• The scope

• Identify the inquiry and support needed to validate the key reasons for
doing the transaction.

• Minimize duplication. Be clear what you want people to do and monitor

them throughout for compliance.

• Prepare information request lists to help the Seller's team prepare for
your due diligence (and expect complaints from them about the length
and scope of the project).

• Reporting findings

• Encourage informal periodic reports from your team (a daily telephone

call is common). The information is fresh and the team's approach can
quickly be redirected based on findings.

• Ask for brevity and only comments that add value (price, terms, etc.).

• Be clear as to what can be discussed with the other side and when.

• Post-transaction integration

• Ensure that those who have to achieve any integration program are
involved with the transaction process. Dont wait until the transaction
and due diligence are complete.

• By anticipating transition issues, the data needed can be developed during

the due diligence process.

iV
 Se a ate he Cri ie Issue o he sh L st

Everybody on your team will have insights and an opinion. The trick is to separate and link the
ones that are important from the ones that are just nice to know. Try to divide them into buckets:
issues that are deal breakers; issues that could have an ongoing effect on the business; issues
which can be resolved by contract; and issues that are throwaway negotiation points.

True "deal breakers" are those issues which cannot be resolved by contract or price adjustments.
They should be identified early to minimize wasted efforts. Deal breakers usually go to the
"body" of the transaction.

Ongoing issues are usually the most critical in any transaction because they relate to the true value
of the business. Look for the trend issues such as those pertaining to production and margin
performance, market share, product development, technology, management, etc. The purchase
contract cannot easily accommodate these issues without adjusting either the price or payment
terms. The purchase contract can, however, usually address one-time issues such as the
recoverability of a particular asset, litigation or tax exposure, and environmental issues. That's
what escrow or indemnification features are for.

There are, however, no distinct lines between each of the categories. Sometimes it's hard to
distinguish between them. For example, an unfavorable commitment to buy raw material might be
addressed through a price adjustment in the acquisition contract, even though it has an ongoing
effect on the business. Conversely, a one-time environmental exposure might be so material that it
renders the business unstable. It's your decision, but use the bucket format as a guide.

Also, remember that every issue should still be measured against the original "why" criteria of the
transaction.

4. Translate the Findings into Value

Each of the due diligence findings then needs to be translated into value. Does it warrant an
adjustment to the purchase price or to the terms and conditions of the agreement? Again, there are
no set rules and your reasons for completing the transaction (the "why") will be the driving force.
This is not the forum to discuss negotiation skills, but we offer the following suggestions when
approaching a value problem:

• Where possible raise the issue in terms of earnings or cash flow trends. If the
original purchase price can be categorized in terms of a multiple (e.g., of prior year
earnings or cash flows) then any adjustment to that base will have a compound
effect on the price. Contrast this with an adjustment based on a closing balance
sheet, which is usually just dollar for dollar.

• Consider an earn-out option or Seller paper, particularly if you are asked to believe
in a fiiture event. These options allow you control of the business yet offer the
ability to share risk. They can also afford the Seller an opportunity for an
attractive return and a graceful solution, without an obvious price reduction.

V
FIRST, within we have a group of specialists
specifically dedicated to due diligence. We have the functional expertise. We've done it for years, with
almost every conceivable mix of client and industry. Simply, we know how to do it.

SECOND, we draw upon the knowledge and resources of our industry consultants and technical
experts to provide you with genuine industry expertise.

THIRD, we tailor our work to meet your specific needs. It is not a standard product. The scope is
based on issues that are of concern to you.

FOURTH, our specialists are independent of your transaction and can provide a creative, but objective,
perspective.

The work we do can include financial, operational and competitive investigations. Again, the scope of
our work is dependent on your needs and is not a standard process. The following examples illustrate
the range of services we can provide in due diligence assignments:

financial Accounting Analysis

We analyze whether financial statements represent actual performance and whether future
projections are reasonable.

Operational Analysis
We analyze current and prospective levels of operatio.nal efficiency through work on revenue
and cost structure. We evaluate prospective expenses, and review supplier contracts and key
customer relationships. We also identify efficimcy enhancements and cost-reductions.

Competitive, Product Line and Iztdustry Analysis

We investigate pricing strategies, competitive advantages, market share, and industry trends
and risks. Customers are surveyed to determine future purchasing plans. And we review
management's plans for challenging competitive forces, and whether cash flow projections
address possible competitor actions.

Cash ’Flow Forecasting

We analyze projections in light of historical performance, industry expectations and strategic
plant.

Tax end Accounting Structuring

We help to structure your transaction to minimize your tax burden, and to achieve the desired
financial accounting presentation.

vii
We help to link the due diligence findings to the transition plan and realize identified
synergies.

AdJitional Services
We also include reviews of employee benefits and compensation, insurance, management
information systems and potential environmental liabilities. In addition, business and asset
appraisals are performed to allocate the purchase price for tax and accounting purposes,
collateral financing, insurance and local property taxes.
1. GENERAL
BACKGROUND.
How do you decide to commit your resources to
reviewing a candidate in detail? Answers to the
. questions in this section will help you determine if
, a company will make a worthwhile target for
, further study. In general, the more background
information you gather in the first stage, the
better position you are in to understand a proposed
trans- action, anticipate crucial issues and
determine a candidate’s willingness to negotiate. n

1
 Yes No Notes

Ba k ou d
1. Do you have the basic information you need about
the company, including the:
a. History of the business, any predecessor companies
and changes in capital structure, capitalization or
insolvency proceedings? a o
b. Description of products, markets, facilities
principal customers, any subsidiaries and their lines
of business? o n
c. List of officers and directors, with their
affiliations, ages and number of years in office? o o
d. Number of people employed, their educational
background and their major areas of activity?
». Capitalization and stock distribution, including the
number of shareholders and names of principal
shareholders, rights of each class of stock and
stockholders' agreements?
f. Terms of outstanding warrants, options and
convertible securities? Find out if these would have
to be dealt with by issuing additional shares.
g. The exchanges on which the company's stock is
traded or, if over the counter, the dealer
making markets, the extent of public float,
institutional holdings, trading volume and total
market capitalization? Obtain any SEC filings
and a shareholder list, if available.
h. Organization chart?
i. Names, addresses and contacts of company's
professional advisers, including attorneys, auditors,
lenders and investment bankers? o o
j. Locations of company's financial and legal
records?
k. State of incorporation and date incorporated? o o
2. Are you aware of the aspects of the business that appear
to be dominant in the industry (e.g., technology, product
design, marketing, production)? Note what appear to be
the key factors for success in the industry and how the
company measures up in these areas.
 Yes No Notes

3 Do you understand whether historically, the company is

a leader in the development of new products in their
industry or do they imitate the new product ideas of
other companies? a n
4. Do you understand the unique factors that have
accounted, over the last five years, for the growth in
sales and after-tax earnings? n n
Do you know what factors make the company more or
less attractive than other companies in the industry?
6. Does the company have a competitive advantage? If so,
determine if the company can strengthen or maintain its
advantage, identify developments that could cause the
company to lose that advantage and assess the likelihood n n
of their occurring.
7. Would the company provide a "platform" to other
desirable industry targets? Identify and evaluate the o n
possibilities.
Market Position and Stra e
1. Have you obtained information or made a preliminary
judgment about:
a. The image of the company and its products and
services compared to those of industry leaders? D $
b. The trend of market share? O O
c. Recent major developments among competitors? O O
d. New developments, planned or in progress, in
relationship to the company's position in the
industry? n
e. Special skills and advantages, such as:
• Technical position? n n
• Established market? a n
• New product success?
• Quality?
• Customer service?
• Survival from major setbacks?
f. Cyclical factors affecting the industry? n n
2. Do you understand the effect of the company's internal
growth compared to that by acquisition? o o

3
 Yes No Notes

Management and Human Resources

1. Have you evaluated the reputation of the present owners,
directors, management and professional advisers? n n
2. Have you evaluated the definition and discipline in
specific plans? o o
3. Is there well developed internal communication? n c
4. Are there labor negotiations pending?
i. Will a drastic change in the company’s management or
business approaches be necessaW to meet your
expectations? Will present employees or customers be
able to adjust to achieve your goals?
OJJerations
1. Have you evaluated the capital equipment commitments? D O
2. Do you understand the effect of major operations
discontinued in recent years or that may be discontinued
in the near future?
Financial
1. Does the company have a consistent credit rating? n n
2. Are there contracts and leases nearing expiration? o o
3. Have you considered whether management has done
anything to make the company appear more attractive to
a buyer, such as:
a. Reducing discretionary expenditures for such items
as advertising, maintenance, research and
development, new product introductions or capital
improvements? n
b. Deferring raises or bonuses?
Other
1. Is there any major litigation, pending or potential? D O
2. Do you understand the extent of govenunent regulation
(including EPA and OSHA) under which the company
operates? n
3. Do you understand other external factors affecting the
company (i.e., environmental, political, social,
economic, etc.)? o

4
 . you know the real reason the company is being
ffered fOr sale?
y joiow how long the company has been for sale
if other transactions have fallen through?
y companies in the industry being sold or
)t quired? If so, do you imow the prices? What was
."principal measure of their value and how was price

job will this transaction be perceived in the market?

How will customers, suppliers and competitors react? O
o you have the following general data on the
contemplated transaction
Terms of the acquisition?

o o
brokers or finders repmenting either side of the
transaction? o o
Financing arrangements?
Transactions costs? o o
If any subsidiaries are not wholly owned, the '’
details of outside ownership? Consider completing
a separate checklist for any major subsidiaries with
significant minority interests.
Other companies that the company has a significant
investment in, carried on the equity method?
Consider completing a sepante checklist for each
2. PRODUCT LINES,
MARKTS,
INDUSTRY CONDITIONS
AND COMPETITION.
This chapter moves from the level of general
understanding toward a detailed knowledge of the
candidate’s business. It considers the opportunities
. and risks associated with products, markets, pricing
and competition, all of which will probably affect
both the value and price of the candidate’s business.
Note that such information is unlikely to be avail-
able absent cooperation from the candidate. Z

7
 Yes No Notes

Demand
1. Do you know if demand is:
a. Basic?
b. Created? o o
c. Elastic?
d. Inelastic?
2. Does the company operate in a growing, mature
or declining market?
3. Have you obtained an estimate of the industry's ability to
supply present and anticipated demand?
4. Do you know the ñnportance of domestic and export
demand? Consider the current value of the dollar and its
effect on export sales.
5. Are you aware of the factors that affect demand, such as:
a. General business conditions?
b. Population changes? a o
c. New products, product changes or technological
innovation?
d. Advertising or promotional pressure?
e. Governmental factors (e.g., fiscal policy,
import/export controls, defense activity)?
f. Customer growth? O O
g. Energy availability? O O
h. Ecologicalconsiderations? D O
i. Other O O
6. Can the market be expanded by efforts of the company? O O
7. Do you know how customers use the company's
products? n
8. Are you aware of these basic buying considerations:
a. Price?
b. Quality?
c. Service?
d. Availability? o o
e. Sales?
f. Engineering?
g. Credit terms?
 Yes No Notes

h. Right of return or consignment?

a ket Se nt t o
1. Do you understand the breakdown of the
company's products and markets?
2. What is the expected fiiture growth in the individual
market segments identified? n n
3. Are there any unique factors which should contribute to
maintaining or increasing revenue into the future? o
4. What type of customer buys these products:
a. Individual consumers?
b. Industrial companies?
c. Commercial or financial businesses?
d. Service businesses?
e. Federal, state or local governments?
f. Construction contractors?
g. Railroads? a n
h. Utilities?
i. Other?
D O
5. Is the market segmented by:
a. Type of customer?
b. Geographic location?
c. Product?
o o
d. Channel of distribution?
e. Pricing policy?
f. Degree of integration?
g. Other?
6. Do you know how the company has responded to
n n
market segmentation?
7. Have you analyzed present and potential domestic
and export customers, including:
a. The total number and major types of customers and
the percentage of sales to cach type?
b. Geographical locations and percentage of sales by
location?
Names of principal customers, annual volume of
sales and buying habits?
 Yes No Notes

Any contractual relationships with customers? o o

The extent of government contracting subject to
cost regulations or price redetermiriation?
f. A summary of special discounts and credit terms
offered to significant customers?
g. Possible loss of customers as a result of this
acquisition?
8. Are there related products or industry segments the
company is not now serving?
Sales Performance
1. Do you have a 5-year record of product sales
performance? Indicate the date the product was
introduced and note any significant modifications. Relate
trends to both external factors and company actions.
Note the stages in the products' life cycles.
2. Do you have a forecast of sales expectations and
estimated share of market? Compare it to industry
projections.
n n
3. Are there any seasonal sales patterns and shifts in
established patterns?
Product kines
1. Do you have a reasoned projection of growth or
contraction trends for the product lines' industry or
industries?
2. Have you analyzed historical sales patterns to determine
life cycles and revenues generated by new product
introductions?
3. Do you know what is the products' life cycle in
the company's plans to introduce new products?
4. Have you examined the past and prospective pattern of
product changes in the industry?
5. Do there appear to be new uses for the products?
6. Are there products which the company is currently a n
selling that it should discontinue?
7. Have you looked into the warranty terms that are n n
customarily offered and their cost?
8. Does the product expose the company to a a
significant product liability concerns?

10
 Yes No Notes

9. Is there any product service uniqueness? n n

Marketing
1. Have you analyzed present and probable pricing
policies for the product lines, considering:
a. The sensitivity of both the industry and company
to price changes? n n
b. Whether there is a price leader? n o
c. Whether there is good price discipline? n n
d. Any excess capacity in the industry that might
tend to depress prices? n n
e. Whether the company has been able to pass
along recent cost increases to customers?
2. Have you reviewed sales backlog, accounts receivable, n n
sales correspondence and customer continuity?
3. Do you know the methods this and other companies in
industry use to distribute and sell, including:
a. The channels of distribution and their relative o o
importance?
b. If the company does not sell directly to end users,
conditions in customers' markets? O
O “ c. The
nature and importance of the field sales effort? O
O
d. The manner of compensating sales personnel? O
e. Advertising and sales promotion practices in this
industry? n n
f. Any changing patterns in the distribution process?
g. Any trend among major customers toward
integrating, purchasing substitute products or
otheovise deviating from purchasing from the
company? o o
4. Have you reviewed advertising appeals, media and other
sales promotion programs for cost and effectiveness?

Have vou analyzed distribution and selling costs for the

past few years to determine possible shifts in profitable
customers and products? Describe any unusual
marketing methods relating to foreign sales, including
licensing arrangeliients and joint ventures.

11
 Yes No Notes

6. Have you analyzed the trend of bidding success and

costs, including:
a. Invitations received?
b. Bids submitted?
c. Contracts awarded? n n
d. Average contract size?
e. Cost per contract award?
7. Have you reviewed trends in the major elements of
marketing, including:
a. Market forecasts compared to actuals?
b. Sales cancellations and returns and the reasons for
them?
c. Departmental costs compared to budget?
n a
d. Sales and expenses per salesperson?
e. Customer service costs? n n
f. Shift in product mix profitability?
g. Order processing costs? n n
h. Customer complaints and lost customers?
i. Discount pattern by customer groupings?
j. New accounts opened?
k. Other?
8. Do you know to what extent the company
is overdependent on one or a few a
customers?
Industry Conditions and Competition
1. Have you analyzed the industry's composition and, a a
in particular, recent changes in that composition?
2. Have you determined how many companies operate in
this industry and whether that number has been declining o o
or increasing?
3. Have you reviewed the recent merger, acquisition and
divestiture deals that have occurred in the industry?
Have you analyzed the trends in the prices paid for n n
these deals?
4. Have there been recent plant closings or openings, or
announcements of such?

12
 Yes No Notes

5. Have you examined the degree to which foreign

companies are entering this market, possibly through
joint ventures?
6. Are the market leaders specialists in this industry or have
they diversified into other businesses?
7. Have you determined which factors are critical
to success in this industry?
a. Have you determined who are the industry leaders
and why?
b. What are the principal bases of competition:
• Price (low gross margin)?
• Quality (high gross margin)?
• Service (high margin to wholesalers)?
o o
• Innovation (high R&D expenses)?
n n
c. Does the market leader have a unique strategy?
d. Does this industry have a high rate of business
failure?
e. Have you determined how important high
production volume is to low cost?
f. Who holds the power in this industry and how did
they get it? Do suppliers have more power than
buyers or vice versa?
g. How reliant is the industry on exports and how
vulnerable is it to imports?
h. Is there any product uniqueness, such as raw
materials used, source of supply, nature of
fabrication or manufacturing processes, or unique
market capability or capacity?
i. Other?
8. Have you obtained growth projections and other
industry analyses from hard copy and electronic
information sources?
a. What growth trends is the industry, including its
companies and trade organizations, projecting? n n
b. What trends are industry outsiders, including
consultants, economists and security analysts,
projecting?

13
 Yes No Notes

c. Have you compared growth trends in the industry to

the trends projected by the company and yourself? D
d. Do you understand what expansion is anticipated in
the foreseeable future, and how such expansion will
be funded?
9. Have you determined the extent to which external factors
influence the industry's health?
a. Will existing or pending litigation affect
the production of or demand for the
industry's
products? o
b. Do governmental regulations affect the industry? Is
Congress currently debating the regulation of the
industry? o o
C. Do any environmental issues affect the industry?
Have any new studies been released that would
increase the industry's liability?
d. Are there any potentially adverse political, social
or economic conditions (e.g., trade restrictions,
healthcare, high interest rates, probability of
nationalization or expropriation, currency
revaluation)? n
e. Is the industry vulnerable to any external forces
cutting off their supply?

14
s. oyJit«tTIoxs
i It is critical to evaluate operations in the areas of
plant and facilities, production, purchasing and
inventories. For example, the candidate’s layout and
: manufacturing process may generate new ideas and
opportunity for the buyer. Conversely, the failure to
identify technically obsolete equipment, products
, or methods will significantly reduce the chances of
, a successful acquisition. n

15
 Yes No Notes

}yjtnt and Facilities

btained information on the:
Location and description of plant or plants and
roperty?
b. Proximity to transportation facilities, materials and
labor sources?
Area, including climate and natural hazards? n n
d. Restrictions imposed by building codes and zoning
laws?
Utilities, including availability, usage and rates?
Real estate taxes and other fixed costs?
g. Title to realty and title insurance policy?
h. The adequacy of insurance coverage?
Any liens or actual or potential condemnation
proceedings?
2. Have you obtained land information, including:
Acreage? O O
b. Cost? O O
Assessed value and fair market (appraised) value? D D
d. Current and possible future use and value? O
3. Do you have adequate building information, including:
Description, site plans and current use†
b. Cost, accumulated depreciation and depreciation
rates and policies (or lease terms)? n n
Assessed and fair market (appraised) value?
4. Do you have photographs of the land, buildings and
equipment? n n
o you have all machinery and equipment information
needed, including:
A list of principal machinery and equipment
showing cost, age and condition, accumulated
depreciation, location and departmental use? a
b. Depreciation rates and policies (or lease terms) and
recent changes?
Additions during last five years, by categories? n n
d. Fair market (appraised) value?
Technological obsolescence?
I Yes No Notes

f. Health and safety considerations? Find out if the

plant complies with OSHA and EPA ri ri
regulations.
g. What level of maintenance has been performed?
Review what major repairs or betteiments will
be required.
6. Do you have a list of any surplus and idle buildings

and
1. For construction in process, do you have a detailed
construction budget, cost-tomomplete summaries and
monthly operating budgets through stabilization?
8. Have you analyzed estimated future plant, machinery
and equipment requirements?
9. Have you evaluated maintenance and "housekeeping"
controls?
10. Do you know capitalization vs. expense policies for
repairs and maintenance? ri ri
11. Have you made an industrial engineering assessment of
the adequacy of auxiliary equipment tools, patterns,
material handling equipment?
Production
1. Do you know the nature of the manufacturing process o n
(e.g., assembly, machine shop, extraction, metal
forming)?
2. Have you identified the important elements in the
manufacturing process (e.g., capital investment,
know-how, design of plant, location, skilled labor,
pool of available labor)?
3. Do you know how many orders per day, per week,
per month are manufactured, shipped and o o
warehoused?
4. Have you evaluated:
a. Tàe organisation and departmentalization of the
production process?
b. The basis for and adherence to the
production schedule?
c. The use of economic production order quantities,
bills of material, time and motion studies, formal
scheduling routines based on capacities and
speed and similar techniques?
.
d. Production metbods, e&ciency and layout?
e. Safety and security measures?
 Yes No Notes

f. Storage and inventory requirements and

warehousing facilities? o o
g. Major and critical raw materials, their availability
and price prospects?
h Make or buy practices, purchasing and inventory n n
controls and subcontracting done by others?
i. Critical lead times for materials or tooling and
significant problems experienced? n n
j. Materials handling methods employed such as
pallets, conveyors, vacuum pipe, magnetic lifts,
forklifts, trucks? n n
k. Quality control? O O
1. Industrial engineering? n n
5. Does the sales forecast receive adequate recognition by
production management? a n
6. Is there adequate communication between the
production, purchasing, selling and planning functions? $
7. Have you considered plant and machine capacities? D O
Do you understand shift patterns, overtime frequency,
and the company's use of temporary labor instead of
full-time employees? a n
9. Do you know the general elements of production costs
(materials, direct labor, indirect labor, manufacturing
expenses) and the proportion of each to the whole?
Relate these to industry norms. n
Do you understand cost per unit? a n
Have you determined the relationship between fixed and
variable costs, the break even point and the relation of
volume to the break even level? What are the effects of
noncash costs and cost accounting for idle capacity and
volume variances on analysis of production costs?
Do you know the cause for significant variances from
standard costs of production for the past three years? O O
Are bills of mateñal modified to reflect changing
circumstances? n n
14. Have you reviewed the trend over the past three years in
these elements of manufacturing:
a. Defective production? o a

19
 Yes No Notes

b. Idle time, stoppage, delays, improper materials,

etc,?
c. Labor efficiency? O D
d. Wasteandscrap? D O
e. Absenteeism, accidents, grievances and overtime? O O
f. Coordination of production planning with sales
forecasts, partial or short runs, peaks and lulls? n n
g. Goods manufactured for others whose needs may
change?
h. Labortumover? O O
i. Excess production times and the reasons for them? D O
j. Delays in delivery time? D D
k. Retumedgoods? D D
1. Doivntiines and the reasons for them? O O
ni. Preventive and emergency maintenance costs? D D
n. Engineeringchangenotices? D O
Have you reviewed the trend in the number of days it
takes a customer's order to go through the plant? n n
16. Are there any cost-reduction programs in effect or
planned? a
17. Could possible changes in production methods make the
manufacturing process obsolete? o o
18. Have you evaluated the efficiency of the company's
production process in relation to the induslry?
19. Has the company evaluated any "make" or "buy"
strategies'! o
20. Have you determined what factors might lead to an
increase or reduction in production costs? o o
Materials Management
1. In the purchasing function, have you looked into:
a. The relationship of raw materials to goods bought
for resale?
b. The percetit•s e relation of material costs to sales
over the last five years? n

20
R
.
Yes No Notes

Have you identified principal raw materials or products

required, commenting on fiiture price trends, market
conditions, raw materials supply, competitors' activity
and general economic conditions in suppliers'
industries? o o
Have you evaluated all principal suppliers, locations
and materials or products supplied?
. Are there multiple sources of supply for critical
materials? Does the company use multiple sources?
Note any monopoly suppliers.
o o
. Does the company actively negotiate prices with
vendors or does it have to accept vendor pricing?
. Have you determined the extent of reciprocal buying, if

Has the company negotiated special supply

arrangements with its vendors and do you understand
the terms?
Do you know the company's policy on carrying
inventories of regularly used materials or supplies?
Determine the existence of inventory limits such as
min-max levels and number of months' supply.
Have you considered the effect on the purchasing
function of technological or product line changes?
Have you determined the degree of
centralization/decentralization and autonomy of the
procurement function?

n n
Do you understand the relationship between production
and procurement functions for short- and long-term
planning?
,‘ Have you studied the procurement procedures that are
followed, i.e., authorized requisitions, inquiry, priced
purchase orders, receiving and supplier payments?
Do you know which of these preferred practices are

A formal purchasing manual?

F-ormal use of economic order quantities?
Up-to-date vendor evaluation files (containing o &
delivery and performance reliability records)?

21
 Yes No Notes

d. A formal program of reviewing purchased

materials (value analysis)? o o
e. A program to standardize materials and supplies
throughout the company?
Competitive bidding procedures?
g. Minimal use of vendors "suggested" by operating n n
(as opposed to procurement) personnel?
Lead times established by product and vendor?
Determine the extent to which operating personnel
consider these lead times in requisitioning
materials and the percentage of "Rush,"
"Emergency" and "As Soon As Possible" orders
placed.
Formalized make or buy analyses?
A small purchase system?
k. Commodity specifications?
o o
1. Price standards and variance accounting?
m. Use of inventory and usage records as purchasing
guides?
15. Have you reviewed operating information and trends for
the purchasing department, including:
a. Trend of cash discounts earned?
n n
b. Operating costs compared to budget?
c. Waste, scrap and salvage disposals?
n n
d. Rejection of material on incoming inspection?
o o
n e torie nd Co t
1. Do you have information on:
a. Trends in inventory levels by reporting category
and product group (e.g., raw materials, work
in process, finished goods)?
b. Stratification by fast-moving, slow-moving, excess
and obsolete inventory (preferably by units and by
value)?
c. Seasonal inventory fluctuations? o o
d. Inventory turnover (ratio of average inventory to
cost of sales) by product line, line of business,
division or subsidiary? n n
 Yes No Notes

e. Basis of valuation (FIFO, LIFO, average costs),

any recent changes to it and their effect on reported
performance? O O
f. The investment required to support major
sales/customers?
Trends in customer service levels, stock outs,
substitutes, back orders? O O
h. Sales and write-offs of obsolete stock over the
past few years? n n
Maintenance and plant equipment parts
inventories? a n
j. Retumable packages, sacks, containers? n n
k. Arrangements for and experience with inventory
held by others, whether under consignment or
otherwise? O O
l. Extent of any "field warehousing" financing
activity?
ni. Returned product?
2. With respect to inventory costing, have you determined:
a. Whether the cost system is based on job cost
or process cost? O O
b. If standard costs are used, how under and over
absorbed costs are allocated to inventory and cost
of sales?
C. How often are the standard costs updated and what
is the effect on both interim and annual results?
*d. What costs are included in overhead? n n
e. Whether idle plant costs offset inventory unit
costs?
How overhead is distributed?
In ascertaining lower of cost or market value, how
market value is determined (i.e., on a unit basis,
by class or product or on the inventory as a
o n
whole)?
h. If LIFO is used, what is the approximate difference
between LIFO and current cost?
The treatment of intercompany profit in inventory
and its effect on ratio analysis by line of business?

23
 Yes No Notes

j. Does the company use the same costing methods

for financial statements and management reports?
If not, are you taking the difference into account
when comparing interim financial results to
year-end statements? n n
3. Do you have enough information on long-term
contracts, including:
a. Contracts entered into, noting products, types of
customer, price terms, payment schedules, extent
of subcontracting and dollar volume?
b. The method of recording income claims and
provision for losses?
c. Outstanding claims and the probability of
recovery.
d. Cost estimating procedures and an analysis of cost
ovemuui or under runs?
e. Bidding procedures and strategy?
f. If contracts are with the U.S. government,
adherence to its cost accounting requirements?
g. Any disputes or litigation with customers or
subcontractors?
4. Have you reviewed trends of important controllable
elements, including:
a. The frequency and adequacy of physical counts
and extent of adjustments required?
b. The accuracy and quality of perpetual
inventory records?
c. Custodial security over inventories?
d. Management reports on turnover, discontinued
lines, and returns on assets?
e. Inventory security and insurance coverage?

24
W\SOURCES
It 1s important to determine whether employee
costs will remain reasonably stable. A substandard
age scale, a weak incentive system, employee dis-
satisfaction or labor shortages can all lead to grow-
bor problems and costs. In addition, you have
investigate whether a candidate’s personnel poli-
cies, benefits, overtime, wage structure and the like
are compatible with yours and, if not, how long it
ill take to make them so. And finally, you need to
. decide how you are going to retain an acquired
. company’s key employees during the transition.
 Yes No Notes

1. Do you have a detailed copy of all benefit program

rules? Programs to consider include base and incentive
compensation plans, overtime premiums, pensions,
savings schemes, medical, vocational training, workers'
compensation, life insurance, post-employment and
other post-retirement benefits. o o
2. Do you have an analysis of recent trends in the cash
and accrued cost of each of these programs
3. Do you know the number of employees, retirees and
terminated vested employees by sex and age, grouped by
function (e.g., sales, production, purchasing, M.I.S.,
engineering and administration)?
4. Do you have the approximate wage, salary, bonus
and overtime premium costs for employees? Do you
have the cost by employee function (e.g., sales,
production, purchasing, administration)?
5. Have you determined the average pay scale and
fringe benefit for employees?
6 Have you looked into the employee incentive systems
and determined average rates (incentive and hourly), the O D
date the programs were established and the date
standards were last changed?
7.
Have you reviewed the management incentive programs
and understand how they are tied to performance?
n n
8.
Have there been any recent changes (either n n
contemplated or enacted) to incentive programs?
9.
Do you know the timing of incentive payments?
n n
10.
Have you examined all union affiliations, contracts, and
other agreements for significant obligations and/or
pension withdrawal liabilities? o o
11.
Have you reviewed strike history for the past five
years, dates, duration, issues and settlement terms?
12.
Do you know what labor unions are represented in the n n
industry and the general area? Find out if there is any
special organizing effort going on in the area.
13.
Have you reviewed:
a. Labor morale and the handling of labor relations? D O
b. Working conditions, statistics on turnover and
reasons for it? n a

27
 Yes No Notes

c. Policies and procedures for employment, recruiting

and personnel? $
d. Accident frequency and safety inspection reports? D D
e. The trends of medical problems and sick leave? O O
f. High amounts of medical, death or disability
claims? o o
g. The wage and salary administration system?
h. Training programs and apprenticeship systems;
their effectiveness and costs? n n
i. Performance evaluation criteria and its
measurement? n n
j. The productivity of the labor force? n n
k. Any unfilled positions? n n
1. The cost and effectiveness of the personnel
department?
14. Have you reviewed the effect of recent cost-reduction
strategies for personnel and benefits such as early
retirement incentive plans, buyouts and severance
arrangements?
15. Have you looked into the general labor market,
including:
a. The types of skills available in the area?
b. Current pay rates and personnel practices of the
industry and of other companies operating in the
immediate area?
c. Area transportation, community recreation
facilities, housing and schools? o
d. The overall labor situation?
e. What union demands were made in the last
bargaining process and what demands will likely
be made in the next?
16. Do you have the following information on management
personnel:
a. The organization of management functions and
responsibilities? o o
b. Management and key employees, including
position, career path, age, compensation, retention
outlook and management training received?
 Yes No Notes

Any employment agreements or unwritten

understandings? n n
d. The contemplated succession plan? O O
e. Any replacement candidates for present
management? c o
f. Recent key personnel losses to competitors? a n
g. The character and attitude of kev personnel?
h. The extent of business controlled by key
personnel?
17. In evaluating employee benefit programs, have you
reviewed:
a. The details and costs of pensions,
post-employment benefits, profit-sharing, life
insurance, disability insurance, medical benefits,
travel, accident, bonus, deferred compensation and
severance plans? n n
b. The effect and timing of recent pay increases?
G. Vacation and sick pay policies and practices? n a
d. The number of company-provided cars? O O
e. ERISA and tax compliance issues, (pre- and
post-acquisition) including non-discrimination
testing, reporting and disclosure issued? o n
f. The funding status of plans and the performance of
fund managers?
g. Benefits and salary levels compared to those of the
buyer? Determine if either company would need to
upgrade its benefit programs or salaries as a result
of the acquisition. If so, estimate the cost. o a
h. Any stock option or stock bonus plans and the
number of outstanding options? Look into how the
plans would integrate with the buyer's plans or
otherwise be treated.
The overall effectiveness of the benefit and
compensation programs in meeting strategic
business goals? a n
j. The potential effect of managed care on the
company's health care delivery system? Are there
effective alternatives to manage/reduce plan costs?

29
5. FINANCIAL
CONSIDERATIONS.
financial analysis is often essential to identifying operat-
: ing problems. Moreover, competent financial analysis will
contribute significantly to structuring and valuing the trans-
action. The choice of equity or debt and loan repayment
schedules for financing the acquisition will be directly relat-
e ed to information derived from financial data.
. The scope of your study, of course, will depend on informa-
, tion available. If the basic financial statements can be supple-
mented by detail, analyses and statistics of the type included
, in internal operating statements, more extensive comparisons
: are possible.
: Equally important, you must evaluate whether the informa-
. tion produced is accurate, timely and relevant. Volume by
: itself is no substitution for value. n
 Yes No Notes

Financial Data
1. Have you obtained:
a. Audited financial statements? o z
b. Recent registration statements? n n
c. Comparative financial results by major division? n n
d. The most recent unaudited financial statements?
e. Tax returns for the last five years, IRS reports,
schedules of unused loss and investment credit
carry-forwards? n n
f. Projected operating and financial statements? n n
g. The chart of accounts and a description
of accounting practices? D D
h. Sales and order backlog information? Do you
understand how the backlog revenue is computed?
2. Have you met with the company's external auditors and
obtained their perspective on the quality of financial
data, systems and people? n n
3. Have you met with the company's internal audit group
and reviewed their scope and any findings? O O
4 Have you examined operating results, analyzing:
a. Differences between interim and annual reporting
practices?
b. Trends in sales, net income, earnings per share,
dividends, working capital, return on stockholders'
equity and operating cash flow? Determine
compound growth rates. n n
The effects of acquisitions, dispositions and
changes in accounting presentation (either
discretionary or from changes in generally accepted
accounting principles)? n n
d. The cost of goods sold, selling expenses and
general and administrative expenses’! Review these
for significant trends, especially in controllable
costs such as advertising, travel and entertainment
and repairs. n n
e. The effect of intercompany and related party
transactions, particularly if not all of the
company's business is being acquired? Consider
also whether the company has effectively
recognized profit before sale to a third party? n n

32
 Yes No Notes

f. The trends in product return policies and practices?

Are they similar to industry standards? n n
g. Changes in reserves and provision methodology? o o
h All extraordinary and nonrecurring expenses? o o
The significant components of other income and
expenses? O O
j. Annual interest expense and other fixed charges? O O
k. Compensation paid to officers and key personnel? O D
i Legal retainers, consultants' fees and similar
arrangements? Q 0
The terms of the following agreements, where
applicable, and of any other pertinent contracts or
agreements affecting income (excerpting if
possible):
• Bonus or profit-sharing plans?
• Royalty agreements? o o
• Union contracts and employment contracts?
• Long-term leases? o o
• Sales contracts and dealership agreements?
• Management charges.
n. The company's accounting policies:
• Are they applied consistently?
• What would be the effect of acceptable
alternatives?
• What is the potential for changes in generally
accepted accounting principles?
5. For financial ratios, have you compared:
a. Current assets to current debt?
b. Net profit to net sales, tangible net worth and
net working capital?
c. Net sales to tangible net worth, net working capital
and inventory?
d. Collection and payment periods (number of days'
sales in accounts receivable and days' cost of
purchases in accounts payable)?
e. The number of days cost of sales in inventory.
f. Fixed assets, current debt and total debt to tangible
net worth?
 Yes No Notes

g. Inventory to working capital? o o

6. For percentages that analyze the cost of doing
business, have you compared sales or revenue to:
a. Cost of goods sold?
b. The cost of various departments (e.g., the
sales force, computing, finance)?
c. Selected operating expenses: n n
• Compensation of officers?
• Rent paid on business property?
• Repairs? n n
• Bad debts?
• Interest paid?
• Taxes paid?
• Amortization, depreciation and depletion?
• Advertising?
• Pension and other employee benefit plans?
7. Have you checked industry sources for pertinent
data on:
a. Market trends?
a n
b. Economics of the industry?
o o
c. Information and manufacturing technology?
d. Taxes? o a
e. Accounting and auditing implications?
f. Employment benefit plans? n n
Balance Sheet Review
Note: See Chapter 3 for additional analysis of
Inventories and Fixed Assets
1. Have you reviewed the cash position, present and
prospective, including:
a. Listing banks where the company maintains
accounts and related balances?
b. Analyzing total cash by function of account?
n n
c. Reviewing monthly cash balances and inquiring
about unusual fluctuations?
d. Determining whether idle cash balances are
promptly invested?

34
 Yes No Notes

e. Determining whether seasonal bank borrowings are

required? n n
f. Evaluating the company's cash management
arrangements and techniques:
• Are there written policies and practices for
authority, limits, exceptions, budgets, etc.? n n
• Are reconciliations timely and
comprehensive?
• Are discrepancies resolved promptly?
• Are funds pooled to maximize interest a n
benefits?
• Are receipts deposited immediately or
subjected to several steps? D O
• Are collections being forecasted and tracked? O O
• Are due dates being established, and for the
earliest time? n n
• Are discounts taken?
2. For accounts receivable, have you:
a. Obtained an analysis of the total receivable balance
for amounts due from customers, officers,
employees and others? n
b. Obtained "aged" trial balances of the receivable
accounts above? Compare them to aging
percentages for previous years and understand
any trends. n
c. Inquired about customer receivables, including:
• Terms of sales? o o
• The number of customers? o a
• The names of large customers and the
volume/value of annual sales to each by
product line? Find out if there are any unusual
arrangements with any of these customers.
• Turnover? o o
• Credit policies?
• The amount of unfilled orders? o o
• The effectiveness of the credit department?
• The real significance of credit limits?

35
 Yes No Notes

d. Scheduled the ratio of returns and allowances to

sales by month for the last year and inquired
about ductuations? Is there any evidence of
dissatisfaction with the company's products? n n
e. Determined whether customers' receivables are
discounted to finance operations? n n
f. Ascertained the purpose and repayment terms
of loans (other than minor amounts) to officers
and employees? D O
g. Determined the adequacy of management estimates
regarding reserves against accounts receivable?
Analyze the trend over a reasonable period of time?
h. Evaluated the collection efforts? O O
3. For prepaid expenses, deferred charges and other
assets, have you:
a. Obtained a listing of securities and investments
held by the company, showing the cost, carrying
value and market value of each item?
b. Obtained details of the cost, market value (if
available), earnings and dividend history of any
investments carried on the equity method?
c. Understood the reason for the deferral of charges? D D
d. Determined the amortization policy for any prepaid
expenses or deferred charges? n n
e. Determined how any goodwill or other intangibles
arose and how they are being amortized? n n
f. Investigated the nature of any other assets?
4. For accounts payable and accrued expenses, have you:
a. Obtained an analysis of the type (vendors, taxes,
payroll, payables on reimbursable contracts,
etc.) and described payment practices for each? n
b. Compared the balances in the various accounts
with those at the end of the previous month,
quarter and year? o o
c. Considered the company's practice of satisfying its
obligations?
d. Determined whether the company takes appropriate
advantage of discounts for prompt payment? n

36
 Yes No Notes

e. Obtained a list of the company's principal

suppliers, together with the approximate annual
amounts purchased by product group? Note any
delinquencies in settlement of vendors and
suppliers' accounts.
f. Asked about the amounts of outstanding purchase
commitments?
g. Asked about any other nonfinancial current
liabilities? a n
h. Understood the company's policy on vacation and
sick pay accruals? Do key employees have
significant vacation entitlement accrued? a a
i. Evaluated long-term purchase contracts? n n
5. For contingent liabilities, have you inquired about:
a. Contracts and agreements to which the company is
a party? n n
b. Price redeteimination or renegotiation?
c. Sales subject to warranty and service guarantee? a a
d. Product liability? n o
e. Unfunded past service cosu of pension plans?
f. Antitrust matters?
g. Any possible equal opportunity employment
problems?
6. Have you determined the purpose of any reserves,
obtained an analysis of activity and determined
the extent to which reserves are discretionary'?
7. Have you inquired about any other liabilities?
Financing and Capital Structure
1. For borrowings (short- and long-term), have you:
a. Listed the amounts of all financial liabilities and
determined the general terms of notes, bonds and
mortgages payable (e.g., lender, payment
schedules, interest rates, seniority, personal
guarantees and other pertinent information)?
n n
b. Noted the nature and exact amount of assets
pledged as collateral?
c. Noted aggregate payments due?

37
 Yes No Notes

d. Discovered the nature of advances and repayment

terms for any amounts due to officers and
stockholders? o o
e. Determined the terms of indentures ar.d ascertained
that all covenants have been complied with? D O
f. Determined whether there are any restrictions in
the indentures that would interfere with the
acquisition?
g. Obtained credit reports? D D
h. Obtained bond ratings if the debt is publicly held? O
i. Obtained the terms of capitalized leases and
long-term non-capitalized leases?
j. Inquired into any quasi-financing agreements (take
or pay contracts, etc.) and guarantees of debt of
other entities?
k. Obtained information on any established lines of
credit, terms and unused amounts available? n
2. Have you obtained details of any preferred stock
outstanding and determined if the terms of the stock
specify treatment in an acquisition or merger? o o
3. For common stockholders’ equity, have you:
a. Obtained a shareholders' list? O D
b. Determined the rights of each class of common
stock? n n
c. Reviewed any treasury stock acquisitions,
determined whether any treasury stock is "tainted"
for purposes of pooling interests and ascertained
that none is carried as an asset?
d. Determined whether the company has any
obligations to issue or repurchase shares? $
e. Inquired about the company’s past dividend policy? CI O
f. Inquired about any unusual capital
accounts (donated capital, appraisal
surplus, etc.)?
4. Have you determined the percentages of the company's
capitalization represented by the various types of long-
and short-term obligations? n
5. Have you determined interest and fixed charge coverage
for the last five years?
 Yes No Notes

Have you received the source and use of funds

statements for the last few years? o o
Have you determined the extent to which the company's
growth has been (or could have been, ignoring
nonrecurring transactions) financed by internally
generated cash? Analyze the implications for the
combined enterprise.
8. Have you inquired about the company's policy
on financial needs? n n
9. Have you evaluated the company's relationship with
banks, lenders and the financial community in general?
10. Have you determined whether the existing debt
repayment schedule can be met from operating cash
flow? If refinancing will be necessary, determine the
effect of current interest rates.
Stand-Alone Considerations
1. Have you evaluated the company or its ability to operate
on a stand-alone basis? In that regard, consider:
a. The degree of autonomy
b. Management resources
2. Do you understand the nature of services performed by
affiliates and the costs charged, if any? Have you
estimated whether they will increase or decrease after
the contemplated transaction?
a. Have you considered:
• Legal?
o a
o
• Accounting?
o o
• Audit?
n n
• Management information systems?
• Employee benefit administration?
• Treasury and cash management?
• Purchasing?
o
• External financial reporting?
n a
• Tax compliance and planning?
n n
• Security?
o o
• Executive management?
• Sales and marketing?
• Production?

39
 Yes No Notes

• Warehousing? n n
• Distribution?
3. Do you understand the methodology used to allocate
corporate costs to the operating entities? o o
4. Are services rendered to or by the company at no cost?
Obtain an estimate of such costs on a stand-alone basis. O O
5. Have you obtained an analysis setting forth purchases
and sales of products from affiliates and inquired as to
the basis for the pricing and its expected continuance?
6. Will the company incur more or less cost for
the following items as a stand-alone entity:
a. Employee benefits?
b. Insurance coverage?
G. Raw materials and services?
d. Workers' compensation coverage? o o
7. Have you considered the effect of one-time or
nonrecurring cosu associated with:
a. New facilities (opening, closure, modification)?
b. Computer equipment (integration, upgrade)? n n
c. Systems (integration, upgrade)? o o
d. Benefit programs (design, modifications)? n n
e. Hiring of additional personnel (and learning
curve)?
f. Moving costs?
g. New management oversight and control?
Prospective Financial Information
Note: For additional areas, see the Planning segment of
Chapter 6 on Management Styles and Practices.
1. Have you obtained available forecasts or projections
of earnings, balance sheet and cash flows? If possible,
obtain the pessimistic, optimistic and most probable
results. n
2. Did you subject the projections to the same ratio
analysis applied to historical results and determine that
relationships are reasonable?
3. Have you determined and evaluated the reasonableness
of the assumptions used? o o
 Yes No Notes

4 Are projections consistent with industry and overall

business expectations? O O
Have you compared previous projections to actual
results? n n
6. Have you considered the effect of product life cycles on
the projections? n n
7. If no projections are available, have you developed
forecasts based on continuing historical growth trends,
industry conditions and known factors? O O
8. Did you adjust projections for any items resulting
from the acquisition? n n
9. Have you reviewed cash flow projections (or developed
them if unavailable) to determine that investment in
working capital, new plant and equipment and scheduled
debt maturities is appropriately provided? Determine
the net cash flow that would be available to the owner
(preferably a range of minimum and maximum cash
flow°)
n n
10. Have you considered the effect of existing intracompany
trading relationships and profits? O O
11. Did you relate the cash flows developed to the proposed
purchase price, using net present value or similar
techniques? O O
12. Are the projections used as a basis for valuing the
company? If so, do you understand the key assumptions
in that valuation and what type of review work could be
done to help verify the validity of the assumptions? n n
Financial Management
1. Have you formed an opinion about the overall
credibility and reliability of the accounting and reporting
of the company? Consider the effects of private vs.
public ownership, tax-oriented accounting and the
attitudes of senior management. o n
2. Has the company changed auditors recently? If so,
inquire as to the reasons. n n
3. Has there been turnover in senior financial
management? What are the causes?
4. Do you know to what extent the company’s earnings n n
have been "managed?"

41
 Yes No Notes

Is the company audited by an independent accounting

firm? If so, investigate the firm's reputation. D O
6. Have the accountants for the buyer reviewed the
working papers of the company's auditors to note the
adequacy of auditing work, the adjustments proposed by
the auditors, problem areas arid any differences of
opinion between the company and its auditors? a a
7. Have you reviewed the adequacy and sophistication of
the internal auditing department? Find out what its
major recent findings were, if"operational audits" have
been conducted and what those findings were. O O
8. Have you assessed the adequacy of internal accounting
controls and the company's attitude toward strong
controls? O O
9. Are you alert to any practices adopted to make the
company appear more attractive, including:
a. Adoption of less conservative accounting policies? O O
b. Cutbacks in discretionary expenses, such as
advertising, personnel, research and development
and maintenance? O O
c. Aggressive accounting judgments, such as
inadequate provisions for sales returns, obsolete
inventories or contingent liabilities?
d. Company e.xpenses being paid by stockholders,
directly or through bargain pricing (e.g., lease
arrangements)? O O
e. Whether stockholder-managers are drawing
inadequate compensation? D O
f. Incentives to be given to employees upon
successful completion of the transaction? a
10. Have you assessed the capability and strength of the
financial management? a
11. Have you determined:
a. How often internal reports are issued (monthly,
quarterly or not at all)?
b. How soon after the end of the period the reports
are available and if they are used?
C. Whether the internal reporting timetable and
content are consistent with the buyer's monthly
closing requirements? D O

42
 Yes No Notes

d. What changes may be needed and what their cost

and training implications are? o o
12. Have you reviewed whether subsidiaries have
autonomous accounting department that may not be
functioning uniformly and, if so, how overall control is
exercised?
13. Do you know how accurate interim reports are? Are
they automatically generated by the system or
prepared independently? Are there significant
adjustments made at year-end which should be given
retroactive effect during the year?
14. Have you investigated:
n n
a. If interim reports are prepared on a consolidated
basis or only by autonomous entities?
b. How foreign subsidiaries or branches report? o o
15. Do you know how management information reporting is
integrated with financial accounting? Find out if
management reports compare resulu to budget and prior
years.
16. Are controllable and uncontrollable costs separated in
departmental reporting?
17. Does management reporting provide the right o o
information, the right amount and a sufficient base to
take corrective action as needed?
18. Have you considered how exception reporting is used?
Electronic Data Processing (EDP) o a
1. Have you listed all significant accounting and
operational functions currently supported by computer? O D
2. Have you obtained a list of hardware and software used
by the company and is it up-to-date?
3. Does the company own or have access to the source
code for its software? Will the source code form part of
the acquisition? o o
4. Are the software systems vendor-supplied or
internally developed?
5. If systems are internally developed, have you determined
whether the system documentation is sufficiently
current to enable subsequent maintenance?
Is the equipment leased or owned? a a
 Yes No Notes

7. Are the input, communications and output systems

effective? a n
8. What is the extent that the system is utilized now
compared to one year ago and what is expected one year
hence?
9. Have you assessed whether the current systems can
accommodate projected growth?
10. How have actual EDP costs compared to budget?
11. Do the EDP costs appear reasonable?
12. Do you know what the company's short- and long-term
software and hardware plans are?
13. What are the projects under development? Do you
understand the timing, progress, budgets and
responsibility for those projects? o o
14. Is the EDP function centralized?
15. Have you determined whether there are major systems
projects that would be curtailed or significantly affected
by the acquisition?
16. Have you assessed the sophistication of the EDP
o o
installation and the extent to which various needs are
integrated?
17. Does the department have adequate resources and o o
is there an overdependency on one individual?
18. Are any MIS functions being performed by service
bureaus and if so, have you understood the contractual
arrangements?
19. What are the company's data security and disaster
recovery plans? Have such plans ever been tested?
20. Have you investigated how the EDP function would
integrate with that of the buyer?
21. Is there any intangible software value? o o
22. Are there EDP links to vendors and key customers? Do
they operate efficiently and effectively or do they require
significant manual interface? Do competitors have

Risk Management
1 What insurance is currently in effect?
2. To what extent is the company assuming large
deductibles or self-insured retentions?
 Yes No Notes

3. What unusual risks or products or events has the

company been unable to insure? (For example,
hazardous waste disposal, pharmaceutical products,
satellite launching.) O O
4. Will the company be able to obtain necessary insurance
in the future? O O
5. What insurance coverage is written on a "claims made"
basis? Have the rights to purchase extended discovery
period coverage been exercised? O O
6. What liabilities have been assumed or transferred
through contractual arrangements? D O
7. What financial techniques are being utilized? Find out
about premium financing, deferrals, use of captives, etc. $ $
Have you reviewed any loss experience for insured and
uninsured claims (property, liability, workers'
compensation)? Have you reviewed reporting and
reserving practices? n n
9 Have any insurance policy aggregates been penetrated
or exhausted? O O
10. Are there any unusual circumstances which may give
rise to claims in the future which are as yet unreported? $
11. Are there any recent or outstanding OSHA violations,
citations or recommendations? n o
12. Has the decision been made whether the buyer or seller
is to assume liability for all prior acts? Will the entity
assuming liability for prior acts be financially sound
enough to back up its indemnifications?
13. Is there potential for cancellation of coverage, such
as Director's and Officer's liability insurance, due to the
sale or to potential bonding problems due to a highly
leveraged condition?
14. Are there any special service agreements that have to be
maintained or renegotiated? n a
15. Are there any premium adjustments (audits, retros, etc.)
outstanding and will either the buyer or the seller receive
credits or charges for them? o o
16. Have you reviewed the methods by which accruals and
tax deductions for premiums are handled? n n

45
 Yes No Notes

17. Does the company have an internal risk

management/insurance department? Assess the
management of the function. o o
18. Has the company been insured in the past by an insurer
that has subsequently become insolvent? Has the
appropriate filing been made with the liquidation and/or
guarantee funds? D O
19. Are there any joint ventures, and, if so, who has the
responsibility to purchase insurance coverage?
Similarly, will the contemplated acquisition involve use
of a common facility/asset, and, if so, who has
responsibility to purchase coverage and how will claims
be realized?
20. Are there any unusual contractual indemnification
agreements which may be inherited?
Taxes
1. Have you reviewed the principal taxes to which the
company is subject and the amounts paid for the
past three to five years? D O
2. Have you reviewed the deferred tax and tax reserve
accounts?
3. If the company purports to be a partnership, LLC or
subchapter S corporation for income tax purposes,
have you ascertained whether such treatment is
appropriate?
a. If a partnership or an LLC, have you reviewed the
partnership/LLC agreement and state law in light
of the IRS revenue procedure for partnership n o
b. If a subehapter S corporation, does the corporation
qualify as a small business corporation? Was an
election timely filed? How is it treated for state
and local tax purposes?
4. Have you obtained detailed reconciliations of the
company's effective tax rate for the past three to
five years?
5. Have you considered recent changes in the tax law that
n n
would affect the company?
6. For federal income taxes, have you reviewed: n n
a. What years are still subject to IRS examination?

46
 Yes No Notes

b. What adjustments the company was required to

make as a result of the most recent revenue agent's
examination? n n
c. If the balance sheet accrual for open years has
been adjusted to give effect to adjustments for
years already examined?
d. If there are any examinations currently in
progress? Find out whether there have been any
preliminary findings or matters under appeal. o o
e. A schedule reconciling book income to taxable
income (Schedule M-1 of Form 1120) for the last
three to five years? Determine that treatment has
been proper. n a
f. Amounts and expirations of any carryovers of net
operating or capital losses, investment tax credits,
foreign tax crediu and other tax credit carryovers?
Consider how the acquisition will affect the status
of these carryovers.
g. What is the tax basis of the company’s assets? O O
h. Whether the company is a member of a
consolidated group? If so, is it party to a tax
sharing agreement? Will any intercompany items
or excess loss accounts be triggered into income
upon sale?
7. For state and local taxes, have you examined:
a. In what state is the company domiciled and in
what states the company has locations from which
it accepts orders and/or does business? Find out if
it is required to file income, franchise, intangible
or other business tax returns in those states and, if
so, whether they have been filed and taxes have been
paid. o o
b. If all state and local taxes have been accrued and
paid currently? Determine if any of these taxes are
in dispute.
c. What percentage of federal taxable income is
being reported to all states in which the company
files returns (i.e., what is the sum of all state
apportionment factors)? Consider whether the
company could owe taxes in states where it is not
currently filing.
d. If there are or have been any state tax audits?

47
 Yes No Notes

e. If adjustments to federal taxable income made by

revenue agents' examinations have been reported to
the states affected? n n
f. If the company is collecting and remitting all
required sales and/or use taxes? n n
g. Whether the company is properly included in any
consolidated, combined or unitary returns for
state tax purposes? n n
h. Any problems with other taxes to which
the company is subject (e.g., real property
tax, intangible tax, excise tax)? O O
8. Have all payroll taxes been withheld from employees
and deposited promptly in an our authorized depository?
Are claims of independent contractor status justified? n n
9 Does the company have any significant foreign taxes or
any significant U.S. tax problems relating to its foreign
operations, such as:
a. Subpart F income? n n
b. Exposure to denial of foreign tax credits because
of potential allocation of expenses to foreign
source income? n n
c. Intercompany pricing and reallocation of income or
expenses between related entities? D D
d. FSC qualification? n n
e. Any transfers of intangible property to a foreign
corporation? n n
f. Has the company provided deferred taxes for
unremitted earnings of foreign subsidiaries? n o
10. Have you assessed all other areas of potential Wx
exposure or savings? n n
11. Have you assessed the impact of the transaction and the
financing thereof on the company's future tax posture?

a. Applicability of Section 338?

b. Applicability of antichurning rules under o
Section 168 and 197.
c. Applicability of limitations on deductibility of n n
interest?

48
 Yes No Notes

12. Has the company tracked "earnings and profits" for tax
purposes? Will earnings and profits be affected by the
transaction? o o
13. Has the company obtained any private letter rulings
or determination letters?
14. For the internal tax function, do you know:
a. If the company has a tax department? Find out
how many people are employed and what functions
are performed. a a
b. To what extent the company relies on
outside attorneys or accountants for ta.x
planning and return preparation?
c. If the tax function has technical expertise or merely
serves compliance functions?
n a
d. How oriented the company is to tax savings? n a
e. If the company maintains good records of items
such as the tax basis of depreciable assets, basis
of subsidiaries, accumulated earnings and profits
and deferred taxes? o o
15. Draft closing documents should:
a. Allocate the purchase price or agree to allocate by
a certain completion date, if the acquisition is an
asset deal or if a section 338 election is to be made.
b. Decide who pays/files transfer and sales taxes. D D
c. State who controls audits of pre-closing taxable
years.
d. Provide for future cooperation and access to books
and records.
e. Include certain indemnifications/escrow provisions. D

49
6. MANAGEMENT
AND
PRACTICES.
Reviewing the candidate’s management is one of
. the most sensitive and critical aspects of your analy-
: sis. You need to understand the roles in the organi-
zation of all key individuals and their
effectiveness, centers of strength and weaknesses,
unclear lines of communication, overlapping areas
of responsibility,
. the degree of delegation, morale and any other fac-
: tors that will affect continuing operations. Consider
whether these styles and practices are compatible
with the buyer’s management team. x

51
 Yes No Notes

Management Approach
1. Do you know whether the basic approach of
management is entrepreneurial, authoritative, or
management by objectives? Determine the extent of
centralization or decentralization of authority.
2. Have you assessed how the company's management
approach will fit with that of the buyer? O O
3 Have you considered the record of the management
team as a whole, including:
a. The success of the company relative to the
industry?
b. The success of management in meeting its own
goals? n n
Whether the success of the company can be
attributed to good management or a good market
and industry? o
d. The work environment management has created in
the company? Are people working together? a a
e. Whether the management is as small in scale and
as low in cost as possible? See if the company
makes any effort to measure the ratio of
administrative managers to total personnel and
otherwise reduce administrative overhead. n n
f. Whether management seems to work as a smooth
integrated whole or is constantly dealing with
crises and emergencies? n n
g. The problem-solving and decision-making
process? Are the right decisions being made at the
right level of management? Find out if executives
are spending most of their time preventing
problems from arising, or if they are using their
time to solve the same problems over and over.
4. Have you determined the extent and effectiveness of
basic concepts and tools of good management,
including:
a. Documented standards and objectives? o o
b. Strategic and tactical plans? n n
c. Responsive organizational structure and controls?
d. Effective policies and procedures? O O
 Yes No Notes

e. Adequate management information systems?

f. Budgetary control and responsibility accounting?
g. Standards of performance and control? o n
h. Management and manpower development?
i. Effective performance measures
Have you reviewed to what extent management is
integrated or permitted to operate autonomously?
Decide if there are any areas in which functions of
the company could be fully integrated. Then estimate
the cost-savings that would result and weigh these
against the advantages of allowing the company to be
fully autonomous (preserving entrepreneurial spirit,
integration costs, etc.).
6. Have you considered lo what extent existing
management will stay on? Consider whether the buyer
will need to provide management expertise in any areas.
7. Does the company have management or operating
expertise that complements any weakness of the buyer? p
Planning
1. Do you understand:
a. The planning process itself?
b. What the company’s attitude is toward the
planning process, long-range as well as annual? O O
c. If plans are well thought out? O O
d. If the plans and budget are real management tools?
O The strategies management is using to increase
market share and profitability? a o
f. The intelligence demonstrated in taking advantage
of anticipated changes in the marketplace and the
environment?
2. Do you know what procedures are used to monitor the
marketplace, such as:
a. Market share? n n
b. Activities of competition?
3. Have you determined who in the organization is
responsible for long-range plans?

53
 Yes No Notes

4. Are the plans documented and communicated to the

people responsible for implementing them? n a
5. In the budgeting process, are sales forecasts based
on real assessments of the market, rather than on
percentage increases?
6. Do you know how costs are estimated and how far
down into the company the budgeting process
extends?
7. Do budgeu embody realistic assumptions of the
availability of manpower, productive capacity and a n
working capital?
8. Are long-range plans integrated with capital budgeting
and financial planning?
9. Do long-range plans consider product life cycles?
10. Do long-range plans reflect competitive reactions?
11. Do plans include alternative strategies? Determine if
they are su&ciently flexible in relation to the operating a a
environment.
12. Are objectives described so achievement can be
monitored?
13. Does senior management judge whether operating
personnel are working toward and achieving specified
objectives?
14. Has the company a history of meeting its goals?
l5. Are the budgeting and internal accounting functions
integrated so that actual performance is reported on the n n
same basis and under the same assumptions as budgets
were prepared?
16. Is actual compared to budget, and is there a formal
procedure for documenting and explaining variances?
17. Is the budget regularly updated?
18. Are there any cost-reduction or profit-
improvement programs?
Internal Controls
1. Do you understand the internal control structure and
the company's attitude toward controls?
2. Have you found out to what extent these basic elements
of control operate:
 Yes No Notes

a. Are the duties and responsibilities within the

company organized to provide segregation
of duties? n a
b. If the company is too small for adequate
segregation of duties, are other elements of control
substituted? n n
C. Are the authority and responsibility of each
function and person clearly defined and
understood? n n
d. Is there an adequate accounting system that
provides control over all assets and transactions?
e Are there documented statement of policies and
procedures?
f. Has the control environment been evaluated either
by an internal or external audit function? Are you
aware of the scope and findings?

55
7. RESEARCH,
DEVELOPMENT
AND ENGINEERNG
O ccasionally, a company that is looking to be
. acquired will eliminate costs that represent a drain
, on current earnings but are essential to long-term
. product development. It is not enough to depend on
a candidate’s past record of success in this area;
instead, you must look closely at its current
: research and engineering capabilities. Evaluate the
. candidate’s strengths in terms of technology, capa-
bility and comparability with your own strategy. ›

57
 Yes No Notes

1. Do you know the quality of product, process and

market research in the company? Compare it to that in
the industry as a whole.
2. Are you familiar with the company's basic source of n n
effective research? The industry's?
3. Have you reviewed industry expenditures for research
and how the company's research expenditures compare?
4. Do you know what the company's policy has been on
research and development? Review the percentage of
sales it has been spending on research and development.
5. Has the research program actually produced any O O
new products during the past five years?
6. What is the status of key product development and n a
research programs?
7. Have you evaluated the company's technical activities
and services by classification (e.g., contract services,
customer services, company R&D, manufacturing
engineering, tool design, product engineering)?
8. Have you reviewed the current and proposed staffing
and personnel requifements for each activity? Are those n o
individuals expected to remain with the company after
the transaction?
9. Do you know the methods of authorization, funding and
reporting for product engineering and company R&D, n o
related to overall research plans and market
requirements?
10. Have you assessed the caliber of the research staff? O O
Find out if the staff has dealt with long-term research as
well as day-to-day product engineering.
11. For contract engineering, are you familiar with the
programs, their tie-in to products and their follow-up
prospects?
n n
12. Have you assessed the type, condition and adequacy of
engineering space and laboratories?
n a
Are proprietary rights on all products under
development adequately secured to the company?
14. Are you aware of any patents and trademarks held or
that have been applied for? Is the protection adequate? $
 Yes No Notes

Is the company protected in foreign as well as U.S.

markets? n n
16. Are any infringement suits or claims outstanding?
17. Are any key patents held by shareholders, management
or other individuals? Find out if the company's rights to
these patents are satisfactory.
18. Do agreements exist under which the company is
licensee or licensor? What are their terms (contract
period, renewal options, royalty payments and terms)? $
19. Have you assessed the relationship between patent
and license life cycles and the company's competitive
position?

59
.
, 8. LEGW
MATTERS
.’ In researching a company, be sure to identify any
, pending or threatened litigation and obtain coun-
t sel’s opinion on the outcome. The consequences
of any error can be severe, and typically, escrow
. accounts or warranties are not sufficient. By
: using professional, independent help, you can
avoid some of the pitfalls. n

61
 Yes No Notes

1. Are any criminal charges or civil suits pending

against the company? o o
2. Have the company's o&cers, directors or employees
been involved in criminal proceedings regulatory
commission violations or significant civil court
litigation? o o
3. Would this acquisition raise any antitrust problems?
o o
4. Has the company made the appropriate Hart Scott
Rodino recognition?
5. Does the company have in-house counsel? Assess
n n
whether it would be more effective to use outside
attorneys. Are there any preferred provider contracts?
O O
6 Have you obtained documentation of claims asserted
and assessed legal strategy going forward?
7. Have you obtained a copy of the most recent legal
o o
representation letters sent to the company's auditors?
Is the company in compliance with environmental, equal
opportunity employment and OSHA requirements? If
not, find out what compliance will cost.
9. Have you obtained legal opinions that stock is validly
issued, fully paid and nonassessable and that the
corporation is in good standing in the state of its
incorporation and all states in which it is doing
business? n n
10. What legal problems have competitors experienced?
Find out if they will eventually confront the company. n n
11. Are there products that need governmental review and
approval? If so, at what stage of the process are they? $ D
12. Are there any international legal issues? O

62
9. ENVIRONMENTAL
ISSUES.
u must analyze the candidate’s exposure to
: environmental issues. Failure to do so can result in
your assumption of significant risk and liability
on occasion even exceeding the negotiated
purchase price. Early analysis is essential given
its potential effect on both terms and price of
a transaction. x

63
 Yes No Notes

1 For public companies: Were there any environmental

disclosures in the annual report filed with the Securities
and Exchange Commission on Form 10-K? n n
2. Do you know if the facility has any Resource
Conservation and Recovery Act (RCRA)
waste treatment, storage and disposal permits?
If so:
a. Have you obtained copies of the RCRA permits? n n
b. Are there any notices of violations or warnings?
c. Are the permits final or in draft and when do
they expire?
3. Do you know if the facility discharges wastewater into
something other than a Public Owned Treatment Works
(POTW)? If so:
a. Have you obtained a copy of the discharge permit? O O
b. Have there been any notices of violation? O O
c. Are there any "treatment facility changes"
required? What are the costs involved? o n
4. Do you know if the facility does use a POTW? If so:
a. Does the POTW require pretreatment? O D
b. If so, what are its estimated costs? n n
5. Do you know if the plant has generated hazardous water
(as defined in Section 3002 of RCRA)? If so:
a. Have these wastes been stored or disposed? n n
b. What is the volume of waste in any one year? O O
6. Do you know if the facility has any air discharge
permits? If so:
a. Has management filed any SARA Title III,
Form R reports?
b. Has management evaluated equipment
requirements or production restraints imposed by
the Clean Air Act (CAA)? n n
C. Has the facility booked any emissions reduction
credits?
7. Do you know the current and historical use for
the seller's property and any adjoining property? n
 Yes No Notes

8. Has the property or any adjoining property been used

as a gasoline station, motor repair facility, commercial
printing facility, dry cleaners, photo developing
laboratory, junkv,ard or landfill, or as a water treatment,
storage, disposal, processing, or recycling facility?
9. With respect to the property, are there, or have there
been any:
a. Damaged or discarded automotive or industrial
batteries, or pesticides, paints, or other chemicals
in individual containers of greater than 5 gal (19L)
in volume or 50 gal (190 L) in the aggregate,
stored on or used at the property or at the facility?
b Industrial drums [typically 55 gal (208 L)] or
sacks of chemicals located on the property or at
the facility? o
c. Pits, ponds, or lagoons located on the property in
connection with waste treatment or waste disposal? D
d. Soil flooring, drains, or walls located within the
facility that are stained by substances other than
water or are emitting foul odors? n
10 If the property is served by a private well or nonpublic
water system, have contaminants been identified in the
well or system that exceed guidelines applicable to the
water system or has the well been designated as
contaminated by any government environmental/health
agency? O D
11. Does the owner or occupant of the property have any
knowledge of environmental liens or governmental
notification relating to past or recurring violations of
environmental laws with respect to the property or any
facility located on the property? n
12. Has the owner or occupant of the property been
informed of the past or current existence of hazardous
substances or petroleum products or environmental
violations with respect to the property or any facility
located on the property? n

66
 Ye No Notes

13. Does the owner or occupant of the property have any

knowledge of any environmental site assessment of the
property or facility that indicated the presence of
hazardous substances or petroleum products on, or
contamination of, the property or recommended further
assessment of the property?
14. Does the owner or occupant of the property know of
any past, threatened, or pending lawsuits or
administrative proceedings concerning a release or
threatened release of any hazardous substance or
petroleum products involving the property by any owner
or occupant of the property?
15. Have any hazardous substances or petroleum products,
unidentified waste materials, tires, automotive or
industrial batteries or any other waste materials been
dumped above grade, buried and/or burned on the
property?
16. Is there a transformed, capacitor or any hydraulic
equipment for which there are any records indicating
the presence of PCBs?
17. Concerning surrounding properties and off-site,
third-party facilities:
a. Do any of the following Federal government record
systems list the property or any property within
the circumference of the area noted below:
• National Priorities List - within 1.0 mile?
• CERCLIS List - within 0.5 mile?
• RCRA TSD Facilities - within 1.0 mile?
b. Do any of the equivalent state lists identify
property within similar boundaries to those listed
above in the Federal records?
c. Have you obtained a list of off-site disposal
facilities used along with the types and amounts of
waste disposed?
o a
• Have you determined the regulatory status of
those ofF-site%spo fâcilides?
d. Has the facility ever used a third-party company
for tolling? If so:
• Have you determined the regulatory status
of those third-party facilities?

67
 As due diligence proceeds, investors typically con-
t stmct a detailed financial model of the candidate’s
business. Effectively, this allows the team to focus on
the issues that translate into value. The model should
. enable you to see how the candidate’s business has
per- k formed to date, reflect
transition issues and project future performance. It
should also permit you to evalu- ate various “what if
”scenarios and to stress-test the most sensitive
assumptions. Most importantly, the
model helps to translate the results of your due dili-
gence into its effects on the proposed purchase price.
As always, the key question to be answered is: “Does
the purchase price still make sense?” n

69
 Yes No Notes

Have you constructed a financial model to reflect the

acquisition and its prospective performance?
2. Does the model present conservative, likely and
optimistic versions? n a
Do projected results appear reasonable in the light of:
a. Historical patterns? o o
b. Industry conditions?
c. Competitive response to target strategies?
n n
d. Transition risk?
n a
e. Technological development?
n n
f. Product life cycle?
g. New tax bases?
4. Does the model include: n n
a. Historical balance sheets, cash flow and income
statements for at least three annual reporting
periods?
b. Prospective balance sheets, cash flow and income O O
statements for at least five annual reporting periods,
preferably ten?
c. A balance sheet, cash flow and income statement by
month for the first twelve to twenty-four months
post-acquisition? D O
d. A source and use of funds from the acquisition?
e. Detailed written assumptions? o o
f. The effects of accounting for business combinations
(e.g., pooling of interests, or purchase accounting)
or a recapitalization?
g. Sufficient data to redect seasonal/cyclical patterns? D O
h. The performance of individual product groups
and/or business lines? o o
i. Segregated line items for extraordinary items,
interest, depreciation and amortization expenses,
and capital expenditures? a a
5. Has inflation been considered? If so,
a. Is a general inflation rate assumption correct?
b. Should the inflation assumption be specific to a
segment of the business? o o

70
 Yes No Notes

c. Does inflation affect revenue and costs

equivalently?
d. Is the industry so competitive that only the
dollar impact of costs can be passed along in o o
prices?
6. Does the model present the acquired business as a
stand-alone entity or integrated with other businesses? If
the latter, does it identify that the effect of the acquired n n
business be identified?
7. Have integration costs been considered?
8. Does the model redect the effect of the transaction on:
a. Employee benefit programs?
b. Employee compensation and options?
9. Has the target paid significant noncash compensation to
its employees in the past? Will this practice continue n o
post-closing?
10. Do the assumptions for the model include:
a. The discount rate?
a o
b. Growth/decline rates for all key areas (sales, costs,
etc.) ?
c. Details of cost-savings expected? n n
d. Detailed costs of the transaction?
e. Capital expenditure and depreciation?
f. Details of noorecurring items of expenditure or
income?
11. Does the model reflect the appropriate tax basis for the o o
business, and are both current and deferred taxes
presented in recognition of such?
12. Does the model detail the financing sources for the
transaction and correctly distinguish between
instruments that are paid in cash or in kind?
13. Does the model present key line items such as: O O
a. Gross margin? a o
b. Operating income?
c. Earnings before interest and taxes (EBIT)?
d. Earnings. before interest, taxes, depreciation and
n n
amortization (EBITDA)? o
e. Working capital?
f. Earnings per share (primary and fully diluted)?

71
 Yes No Notes

g. Return on assets?
h. Days sales outstanding in receivables?
i. Days sales in inventory? n o
j. Days cost of sales in payables? n n
14. Is there an exit strategy to be considered in the model? If
so, is there a terminal (residual) value for the business at
the end of the projected period?
a. Docs the terminal value accurately reflect average
or expected market conditions at the time of exit? $ $
b. If a perpetual cash ßow is specifically modeled, are
the expected long-term growth rates and asset
retums realistic?
15. Have you stress-tested the model for the most sensitive
assumptions?

72