Due Diligence Guidance
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DILIGENCE GUIDANCE
Name of document: Due Diligence Guidance
Documentation purpose: Internal reference
Documented time:
Prepared by: Pham Cong Sang ([email protected])
Reviewed by:
Type of document: For internal use and open for updates
Due Diligence – Definition and Significance
Due Diligence As usually accepted by financial investment universe, Due Diligence is the process of
investigation, performed by either by buy-side or sell-side, into the details of a potential investment. From the buy-side point of
view, such an examination includes, but not limits to, the operations, financials, legal compliance and management and the
verification of all other facts that deem material. Served to confirm all material facts and to prevent unnecessary harm, Due
Diligence refers to the comprehensive care a reasonable buyer should take before entering into an investment transaction.
Due diligence takes place throughout a transaction (from kick-off to closing) and includes document review as well as meetings
with the issuer, the underwriters, the auditors, local counsel, and may include meetings with industry experts, regulators,
shareholders and others depending on the circumstances.
The following Due Diligence Checklist (“The Checklist”) is only a general template that covers a wide range of investigation
aspects. The Checklist may, therefore, differ from the actual list that is necessary for a particular investment deal’s due diligence.
If it is the case, a customized checklist that is based on this general template will be created.
For avoidance of confusion, the Checklist aims at being a reference for a wide range of equity investments rather than
investments made in banking industry.
1. Organization
Checking the legality of the target company (“Company”).
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1 ✓ Obtaining articles or certificate
of Incorporation
✓ Obtaining corporate structure with helpful diagrams or charts, providing a list of
directors and a brief description of their duties, experience and education background.
✓ Obtaining minutes of Board of Directors and Shareholder meetings for the last 3-5
years.
✓ Obtaining list of all associates and subsidiaries and other entities and partnerships in
which the Company has an equity interest, showing by organizational charts ownership rate.
2. The Board
Checking the Board’s Independence from
✓ Getting to know size of the Board: No universal agreement on the optimum size of a
board of directors, a large number of members, however, represents a challenge in terms of using them effectively and/or having
any kind of meaningful individual participation.
Due Diligence Guidance
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and the monetary resources for obtaining expert help in specialized areas.
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2 ✓ Determining whether the
Company has, at a minimum, a majority of Independent Board Members and there exits two critical board committees that must
be made up of independent members: compensation committee and audit committee
✓ Determining whether the Members have the qualifications the Company needs for the
challenges it faces.
✓ Determining whether the Board and its committees have budgetary authority to hire
Independent third-party consultants without having to receive approval from management.
✓ Investigating whether the Company engages in outside business relationships with management or Board Members, or
individual associated with them, for goods and services on behalf of the Company.
3. Ownership and
shareowners’ rights
Investigating the ownership structure and the rights associated with the securities of the Company which partially determine the
value of the financial security.
✓ Obtaining the capitalization of the Company, including number of outstanding shares
(common and preferred), convertible securities, options, warrants and other similar instruments.
✓ Obtaining the holding structure, including holding of the state, public, directors and
employees
✓ Obtaining the list of individuals and/or institutional investors holding more than 5% of
the Company’s common shares.
✓ Determining whether the Company has employee stock benefit programs
✓ Obtaining copies of any proxies, transfer restriction agreements and any other
agreements regarding the ownership or control of the Company.
✓ Determining whether the Company permits proxy voting and cumulating voting.
✓ Determining whether the Company has different classes of common shares that
separate the voting rights of those shares from their economic value.
4. Financials
Combining financial reports prepared by the Company and other information to evaluate the past, current and prospective
performance and financial position of the Company for making investment decisions.
A. Obtaining the following annual and quarterly financials for the past 3-5 years
✓ Financial statements and footnotes (audited statements if any)
✓ Records of planned versus actual results
✓ Management financial reports
✓ Breakdown of sales and profits by:
a. Product and/or service line
b. Channel
c. Geography
✓ Accounts receivable aging schedule
✓ Management’s Discussion and Analysis (MD&A)
B. Obtaining the following financial projections and related information
✓ Quarterly/annual financial projections for the next three fiscal years:
a. Revenue by product line, customers, and channel
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b. Full pro forma income statements, balance sheets and cash statements
✓ Economic assumptions underlying projections
✓ Explanation of projected capital expenditures, depreciation and working capital
arrangements
✓ Schedule of all options, warrants, rights and any other potentially dilutive securities
with exercise prices
✓ Summary of all debt instruments/ banks’ credit lines with key terms and conditions
✓ Off-balance-sheet financing
5. Products &
Services
Completely understanding the Company’s core products and services should be of top priorities.
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3 ✓ Describing each product line by
gaining the insights in terms of:
a. Major customers and applications
b. Historical and projected growth rates
c. Market share
d. Speed and nature of technological change
e. Timing of new products, products enhancements
f. Cost structure and profitability
6. Customers & Contracts
With the utmost effort, obtaining significant information on customers and contracts helps understand the Company’s revenue
insights.
✓ Obtaining the list of 10-15 major customers for the past 2-3 years
✓ Obtaining the list of strategic relationships (name, revenue contribution, marketing
arrangements/agreements)
✓ Breaking down revenue by customer
✓ Obtaining the list of top 5-10 suppliers for the past 2-3 years (name, purchase
amount, supplier arrangements/agreements)
7. Marketing & Distribution
Understanding how the Company delivers its products to users and conveying the competitiveness driven by its marketing and
distribution strategies.
✓ Discussing domestic and international distribution channels
✓ Positioning the Company and its products
✓ Discribing and discussing marketing programs and examples of recent marketing/product/public relations/ media information
on the Company
✓ Discussing status and trends of relatioships with major customers
✓ Discussing prospects for future growth and development with major customers
✓ Discussing principal avenues for generating new business
✓ Understanding the sales force productivity model in terms of compensation, sales
cycle and plan for new hires
✓ Discussing the ability to implement marketing plans with current and projected
budgets
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8. Competitive
Describing the competitive landscape within each market segment including:
advantage
✓ Market position and related strengths and weaknesses as perceived in the market
place To understand how the Company can compete
✓ Basis of competition, such as price, service, technology, distribution
successfully for long, whether the Company has competitive advantage, defined as the Company to perform better than rivals by
doing different activities or to perform similar activities in different ways.
9. Intellectual
Obtaining, at best, the following information relative to IP:
Properties (IP)
✓ All patents, trademarks, tradenames, service marks and copyrights owned or used by
the Company (patent number, issue date, inventors, title, grant date, expiration date, Due to
the increasing
publication number...) importance of intellectual properties for companies
✓ all applications and information about any liens or other restrictions and agreements of all
kinds, an
on or related to any of the foregoing understanding of the Company’s IP status could help
have a comprehensive analysis of the Company.
10. Legal compliance
To eliminate internal legal risks due to legal compliance failures, efforts to convey as much as information regarding legal
compliance will be a plus for the analysis work.
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4 ✓ Describing any pending or
threatened proceedings or investigations before any court
or any regulatory authority.
✓ Describing any circumstance where the Company has been or may be accused of
violating any law or failing to possess any material license, permit or other authorization.
✓ Describing the potential effect on the Company of any pending or proposed regulatory
changes of which the Company is aware.
✓ Obtaining any correspondence with or complaints from third parties relating to the
marketing, sales or promotion practices of the Company.
11. R&D
Serving as a locomotive for the Company’s competitive advantages, R&D activities, upon due consideration, can play a critical
role in determining what the investment recommendation will be.
A. Describing R&D organization relative to:
✓ Strategy
✓ Key personnel
✓ Major activities
B. Obtaining information regarding new product pipeline
✓ Status and timing
✓ Cost of development
✓ Critical technology necessary for implementation
✓ Risks
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12. Tax status
Tax issues and implications always need proper consideration in the course of valuation
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5 ✓ At best effort, determining
whether understatement of tax declarations notably related
to VAT and to management and employees’ PIT and other tax issues exist.
✓ When there are significant deferred tax assets, reviewing the Company’s financial
performance and its accounting choices to assess the likelihood of realization of those assets.
✓ Determining whether the Company has proper allowance for its deferred tax assets.
✓ Studying external and Company-specific factors (expected future tax rates, changes
in accounting methods, the Company’s growth rate, nonrecurring items...) that determine the level of and trends in reported
deferred taxes, to decide whether they are real assets or liabilities (equity in nature) and to evaluate their expected cash
consequences.
13. IT application
Computerization and scope of IT applications can help evaluate the Company’s effectiveness and efficiency
✓ Obtaining information relative to the level of computerization for the Company’s
business processes.
✓ Whether or not the IT personnel existed or outsourced? How much care does the
Company have for its computer system security?
✓ License for software? (Microsoft Windows software, licenses for popular software,
dictionary software, etc)
✓ Checking the legitimacy of the software involved.
14. Land and land-
related issues
Land value as part of the Company’s value may be problematic. Shedding light on this could help the valuation.
✓ Checking if the Company receives LURs and ownership of house/construction works
through:
a. Land allocated from the State b. Land leased from the State
✓ Paid annually ✓ Paid in a lump sum
✓ Checking properties: buildings, factory, and warehouses: Do they have LURs
Certificates? Do they have Certificates of ownership of houses/construction works?
✓ Houses, Office lease contracts: Notarized? Contracts with entities: Do the entities
have the function to lease out houses and offices? Insurance?
15. Environmental
matters
For a better valuation of the Company’s value, all environment-related potential liabilities must be considered.
✓ Checking the availability of the following environment-related documentation:
• Environmental Impact Assessment Report
• Approval for the Environmental Impact Assessment Report
• Report on the Environment Protection
• Pollution Control Certificate
• Periodical Report on Pollution Control
• Waste Water Discharge Permit
✓ Obtaining information regarding any complaints, claims, lawsuits or other documents relating to potential environmental
liability of the Company to any parties involved.
✓ Obtaining copies of any written analyses conducted by the Company or an outside
consultant relating to future environmental activities (i.e., upgrades to control equipment, improvements in waste disposal
practices, materials substitution) for
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which expenditure of funds greater than $10,000 is either certain or reasonably anticipated within the next five years and an
estimate of the costs associated with such activities.
16. Miscellaneous ✓ Obtaining additional information, both financial and nonfinancial, may help the analyst
have a more comprehensive picture of the Company. They include:
• List of major competitors for each business segment or product line
• All annual and interim reports to stockholders and any other communications with security holders
• Description of principal banking and credit relationships (excluding payroll matters), including the names of each bank or other
financial institution, the nature, limit and current status of any outstanding indebtedness, loan or credit commitment and other
financing arrangements.
• Summary and description of all product, property, business risk, employee health, group life and key-man insurance
• Copies of any filings with HOSE/ HASTC related to the Company conducted in the past three years
• All other information material to the financial condition, businesses, assets, prospects or commercial relations of the Company.
17. Top 9 Questions to
ask Management
These questions are offered by investopidia.com as an open source. As having one-on-one conversations with the Company’s
Management is a terrific opportunity to garner timely, valuable information, these questions are included in the Checklist as a
plus during the talks with the Management. The questions are slightly modified from the original version to suit Vietnamese
market. The questions are presented with the implication of each of the answers.
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6 ✓ Question 1: Where do you see
sales trending in the next 12 to 24 months?
This time frame will give us a good glimpse of the opportunities and the risks that could present themselves over both the short
and the intermediate term. In addition, because this is an open-ended question (and not a simple yes/no or one-word answer
question), it allows the manager to give a broad response and perhaps touch on a variety of issues that could prove valuable to the
decision-making process.
✓ Question 2: What are the risks associated with the sourcing of raw material, or
holding the line on costs of services?
This question allows the manager to potentially touch on a variety of factors that could have an adverse impact on raw material or
labor costs related to sourcing. The manager's response may give us some valuable insight into the future direction of gross
margins, which in turn will give some insight into future potential earnings. We will then compare the answer to this question
with the earnings projections that the sell side is making.
✓ Question 3: What is the best use for the cash on the company's balance sheet? How
does the company plan to raise capital in order to fund future growth?
The manager's answer may indicate whether the company is planning a merger or acquisition, if it will use its cash to buy back
common shares in the open market, or if it feels it is better off saving cash for future expansion. This information is particularly
valuable because it may alert us to potential catalysts that could drive the stock, or to potential risks that could depress it.
If we're asking about future growth, we should be looking for a response that would indicate that the Company is taking steps to
improve its place in the market. If the Company isn't growing and is losing cash, then we know what kind of performance to
expect.
✓ Question 4: Who are the emerging competitors in the industry in which you operate?
This question will let us know who the competition is, and/or who it may be in the future. It may also alert us to new
products/services that may be coming to market, which could impact the company at some point down the road. Consequently,
management may also disclose plans on how it plans to deal with these emerging competitors.
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✓ Question 5: What part or aspect of the business is giving you the most trouble now?
The answer will identify potential weaknesses in the Company's organization and provide some insight into future earnings. For
example, if the manager indicates that Division X was forced to pay more in the current quarter for its raw materials because of a
supply problem (and the investor knows that Division X constitutes 40% of the company's total revenues), we could assume with
reasonable confidence that there could be a near-term earnings shortfall.
Keep in mind that identifying problem areas is just one part of the equation. It is far more important to hear what the Company
plans to do to resolve the problem area(s) in both the short and long term.
✓ Question 6: How close are Stock Analysts in terms of estimating your company's
earnings results?
With this question, we are asking if The company will meet consensus estimates. Think about it. If the manager answers that "the
Stock Analysts typically underestimate us", the implication is that they'll keep on doing that, and that there could be some upside
to future earnings. Conversely, if the manager comments that "the analysts are sometimes a little too optimistic", the implication
is that there could be an earnings shortfall at some point in the future.
✓ Question 7: What part of the business do you think is being ignored that has more
upside potential than Stock Analysts are giving it?
Running with our last question, this one will lead the manager into revealing more about the Company's positive points. It will
probably inspire a long answer from the manager, who will undoubtedly love to talk about the positive aspects of the Company
that aren't being represented in the media. His/her answer will also undoubtedly reveal the source of potential upside earnings
surprises, which is important because it may potentially allow us to buy into the stock before the impact (of the earnings) is
actually reflected in the share price.
✓ Question 8: Do you have any plans to advance or promote the stock?
Knowing if and when management plans to promote the stock to individual and/or institutional investors is invaluable, because
we can buy into the stock ahead of what could be a large amount of buying pressure. Individuals looking to time an entry or an
exit point in the stock may also find this particular question to be valuable.
✓ Question 9: What catalysts will affect the stock going forward?
Again, this is an open-ended question, so the manager is likely to give us a wealth of information. In some cases the manager
might highlight the potential for new analyst coverage, the possibility that the Company may have a stronger year than most are
expecting, or plans to promote the stock. Conversely, he/she might yield information about negative catalysts that could adversely
impact the share price.
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