The ins and outs of the due diligence process

Due diligence is not just about assessing a company’s turnover. From financial statements to tax matters, loans and shareholders, there are various elements that need to be investigated during the due diligence process. Jeneen Galbraith of accounting firm Galbraith Rushby, an accounting firm providing a range of services, which include taxation, auditing, financial statements and due diligence, delves deeper.

What does the term due diligence mean?

Due diligence is an investigation of a company, which is usually conducted when there is a merger and acquisition or a new investment opportunity about to take place. The aim of the process is to assure the buyer that they are making the right decisions and investments. 

Would small businesses ever need to perform due diligence on other businesses, or is this the realm of big corporations?

At Galbraith Rushby we service small- to medium-sized (SME) sectors and often business owners looking to buy shares in a company, or merge with another company, so it’s definitely applicable in the SME sector.

How does one decide how much due diligence needs to be done on a company? 

It’s tricky, but a starting point would be to look at the size of the transaction. If you’re dealing with a small start-up that’s turning over a couple of hundred thousand rand a month, you don’t want to overburden that with a huge due diligence process. On the other hand, if you’re dealing with a much bigger company turning over a few million rand a month, you will want to put resources into ensuring you’re making the right decision.

To break it down, the bigger the transaction, the more work you’ll put into the due diligence process, and the more detail you’ll go into. Conversely, the smaller the business, the fewer resources you’ll need. Sometimes I’ll say to my clients, just give me the financial statements of this business you’re trying to acquire and within 15 minutes I can tell you whether there are skeletons in the closet. When dealing with smaller companies, there tends to be a much larger level of trust, but that doesn’t mean you should skip due diligence. It’s an integral part of any acquisition, merger or investment.

What are examples of more complex issues you may look into, in a bigger deal? 

There are legal and environmental factors to look into, and tax matters are important, too. This is where what I call the “hidden skeletons in the closet” often come into play. People don’t always realise the complexity of tax. You obviously need to look at income tax, PAYE, VAT and all the usual taxes, but there can also be hidden taxes such as dividends taxes, and taxes connected to loan accounts, and these often sit in the retained income and the equity. When we start investigating a business, that’s exactly what we’re looking for. We’re looking beyond the basics of whether they have paid their ordinary taxes, which you expect every company to do, and any hidden taxes you may be unaware of. 

What would you be looking out for on the statutory side of the due diligence process? 

We would look at all the secretarial records, who the shareholders are, and if they are local and/or foreign, whether  all the records have been properly kept and updated, and all the directors recorded properly on the register. You’d be surprised how often you’ll find past shareholders that have never been properly exited, or directors that were never properly removed.  

At the end of a due diligence process, what do you hope to achieve?

The information we get about the business helps to decide how to structure the transaction. Should you take shares, should there be loan accounts, and so on. All of this will depend on the current state of the company, and this information can only be obtained through a comprehensive due diligence process. 

This article was paid for by Saica.