5- Due Diligence page.

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1. Introduction
2. BEST PRACTICES IN DUE DILIGENCE IN THE ERA OF
ACCOUNTABILITY 2.0
3. Common Mistakes Made by the Buyer During the Due Diligence
Investigation
4. The Crisis of Disengagement and Its Impact on Due Diligence
5. What Role Can M&A Principals and Advisors Play?
6. LEGAL DUE DILIGENCE
a. CORPORATE MATTERS
b. Financial Matters
c. Management and Employment Matters
d. Tangible and Intangible Assets of the Seller
e. Material Contracts and Obligations of the Seller
f. Litigation and Claims, Actual and Contingent
g. Miscellaneous
7. BUSINESS AND STRATEGIC DUE DILIGENCE
a. The Seller’s Management Team
b. Operations of the Seller
c. Sales and Marketing Strategies of the Seller
d. Financial Management of the Seller
8. CONCLUSION
9. Post-Sarbanes-Oxley Due Diligence Checklist
10. THE DISCLOSURE REQUIREMENTS
11. CHECKLIST OF ITEMS POST-SARBOX
1. Introduction
Sarbox brought new standards for conduct and governance for public-
company boards of directors and officers .
M&A practices and documentation generally are continuing to evolve
in small increments
Accordingly, much of the following discussion emphasizes those
practices prevailing in the Era of Accountability 1.0. Although the
anticipated changes in practices are likely to be incremental, in the
context of ever-expanding government regulation and enforcement
activities.

2. BEST PRACTICES IN DUE DILIGENCE IN THE ERA OF

ACCOUNTABILITY 2.0
Due diligence in this new era requires an increasingly creative and strategic approach, not
just a mechanical methodology.

it is also a reality test—a test of whether the factors that are driving the deal and making
it look attractive to the parties are real or illusory
the FCPA prohibits U.S. and certain foreign companies from bribing foreign government
officials,

sophisticated sellers will try to include a disclaimer in the acquisition agreement

providing that the buyer is relying only on the representations and warranties in the four
corners of the agreement. Such a clause frequently prevents a buyer from bringing fraud
claims against the seller

3. Common Mistakes Made by the Buyer During the Due Diligence

Investigation
1. Lack of planning and focus in the preparation of the due diligence
questionnaires and in the interviews with the seller’s team.
2. Mismatch between the documents provided by the seller and the skills of
the buyer’s review team.
3. Poor communication and misunderstandings
4. Inadequate time devoted to tax and financial matters.
5. Lack of reasonable accommodations and support for the buyer’s due
diligence team. (buyer must insist that his team treated like welcome gusts not like enemies)
6. Ignoring the real story behind the numbers.

4. What Role Can M&A Principals and Advisors Play?

 Strengthen your HR/cultural-related due diligence analytical skills and approaches.
 Bring in Subject Matter Experts (SMEs) and specialists as needed.
 Focus on these issues in pre–due diligence mock reviews.
 Work with legal counsel with strong L&E skills and strategic understanding of
disengagement issues.
 Advise buy-side engagement clients on the risks of acquiring low-engagement
companies.
 Look for disengagement “warning signs” in due diligence on the seller (i.e., dysfunctional
leadership, high turnover rates, an excess of negative social media posts on job-related
or other websites/platforms, lack of succession planning or obvious
turfmanship/protectionism in leadership positions, declining rates of profitability, lack of
innovation, etc.).

 Challenge buyers who think they have the “magic elixir” for curing cultural or employee
performance defects on a post-closing basis (“Oh, this won’t be a problem once we buy
them.” “Yeah, right!?”).
5. LEGAL DUE DILIGENCE

a. CORPORATE MATTERS
1. Corporate records of the seller: that includes certificate of
incorporation, minute books, shareholders list, locations of
business and list of states and countries of the business
 Certificate of incorporation and all amendments
 Bylaws as amended
 Minute books, including resolutions and minutes of all directors’ and
shareholders’ meetings
 Current shareholders list (certified by the corporate secretary), annual
reports to shareholders, and stock transfer books
 A list of all states, countries, and other jurisdictions in which the seller
transacts business or is qualified to do business
 Applications or other filings in each state, for qualification as a foreign
corporation and evidence of qualification
 Locations of business offices (including overseas)
2. Agreements among the seller’s shareholders
3. All contracts restricting sale or transfer of company’s shares (such includes
“but not limited to” first right refusal, stock options, warrants, pledge…etc.)
b. Financial Matters
 Copies of management and similar reports or memoranda relating to the
material aspects of the business operations or products
 Letters of counsel in response to auditors’ requests for the preceding five years
 Reports of independent accountants to the board of directors for the
preceding five years
 Revolving credit and term loan agreements, indentures, and other debt
instruments, including, without limitation, all documents relating to shareholder
loans
 Correspondence with principal lenders to the seller
 Personal guarantees of the seller’s indebtedness by its shareholders or other
parties
 Agreements by the seller where it has served as a guarantor for the obligations
of third parties
 Federal, state, and local tax returns and correspondence with federal, state, and
local tax officials
 Federal filings regarding the Subchapter S status of the seller (where
applicable)
 Any private placement memorandum (assuming, of course, that the seller is not
a Securities Act of 1934 “reporting company”) prepared and used by the seller
(as well as any document used in lieu of a private placement memorandum,
such as an investment profile or a business plan)
 Financial statements of the seller, which should be prepared in accordance with
GAAP, for the past five years, including:

o Annual (audited) balance sheets, and other financial statements in addition

to any monthly (or other available)
 Any recently prepared projections for the seller, and Projected budgets,
accounts receivable reports (including a detailed aging report, turnover, bad
debt experience, and reserves), and related information
 Any information or documentationrelating to tax
assessments,
 deficiency notices, investigations, audits, or settlement proposals
 An informal schedule of key management compensation (listing information for
at least the ten most highly compensated management employees or
consultants)
 Financial aspects of overseas operations (where applicable), including the status
of foreign legislation, regulatory restrictions, intellectual property protection,
exchange controls, methods for repatriating profits, foreign manufacturing,
government controls, import/export licensing and tariffs, and so on
 c. Management and Employment Matters
 All employment agreements
 Agreements relating to consulting, management, financial advisory services, and other
professional engagements
 Copies of all union contracts and collective bargaining agreements
 Equal Employment Opportunity Commission (EEOC) and any state equivalent
compliance files
 Occupational Safety and Health Administration (OSHA) files, including safety records
and workers’ compensation claims
 Employee benefit plans (and copies of literature issued to employees describing such
plans), including the following:
o Pension and retirement plans, including
union pension or retirement plans
o Annual reports for pension plans, if a n y
o Profit-sharing plans
o Stock option plans, including information concerning all options, stock
appreciation rights, and other stock-related benefits granted by the
company
o Medical and dental plans
o Insurance plans and policies (including errors and omissions policies and
directors’ and officers’ liability insurance policies)
o Any Employee Stock Ownership Plan (ESOP) and trust agreement
o Severance pay plans or programs
o All other benefit or incentive plans or arrangements not covered by the
foregoing, including welfare benefit plans

 All current contract agreements with or pertaining to the seller and to which directors,
officers, or shareholders of the seller are parties, and any documents relating to any
other transactions between the seller and any director, officer, or shareholders,
including receivables from or payables to directors, officers, or shareholders
 All policy and procedures manuals of the seller concerning personnel; hiring and
promotional practices; compliance with the Family Leave Act; drug and alcohol abuse
policies; AIDS policies; sexual harassment policies; vacation and holiday policies;
expense reimbursement policies; and so on
 The name, address, phone number, and personnel file of any officer or key employee
who has left the seller within the past three years
 d. Tangible and Intangible Assets of the Seller
 List of all commitments for rented or leased real and personal property, including
location and address, description, terms, options, termination and renewal rights,
policies regarding ownership of improvements, and annual costs
 List of all real property owned, including location and address, description of general
character, easements, rights of way, encumbrances, zoning restrictions, surveys,
mineral rights, title insurance, pending and threatened condemnation, hazardous waste
pollution, and so on
 List of all tangible assets

 List of all liens on all real properties and material tangible assets
 Mortgages, deeds, title insurance policies, leases, and other agreements relating to the
properties of the seller
 Real estate tax bills for the real estate of the seller
 List of patents, patents pending, trademarks, trade names, copyrights,

 registered and proprietary Internet addresses, franchises, licenses, and all other intangible
assets, including registration numbers, expiration dates, employee invention agreements
and policies, actual or threatened infringement actions, licensing agreements, and
copies of all correspondence relating to this intellectual property
 Copies of any survey, appraisal, engineering, or other reports relating to the
properties of the seller
 List of assets that may be held on a consignment basis (or that may be the property of a
given customer), such as machine dies, molds, and so on
e. Material Contracts and Obligations of the Seller

 Material purchase, supply, and sale agreements currently outstanding or projected to

come to fruition within twelve months, including the following:

o List of all contracts relating to the purchase of products, equipment,

fixtures, tools, dies, supplies, industrial supplies, or other materials having
a price under any such contract in excess of
o $5, OOO or equivalent.

o List of all unperformed sales contracts

 Documents incidental to any planned expansion of the seller’s facilities

 Consignment agreements

 Research agreements
 Franchise, licensing, distribution, and agency agreements
 Joint-venture agreements
 Agreements for the payment or receipt of license fees or royalties and royalty-free
licenses
 Documentation relating to all property, liability, and casualty insurance policies owned
by the seller, including for each policy a summary description of:

o Coverage
o Policy type and number
o Insurer/carrier and broker
o Premium
o Expiration date
o Deductible
o Any material changes in any of the foregoing since the inception of the
seller
o Claims made under such policies

 Agreements restricting the seller’s right to compete in any business

 Agreements for the seller’s current purchase of services, including, without limitation,
consulting and management
 Contracts for the purchase, sale, or removal of electricity, gas, water, telephone, sewage,
power, or any other utility service
 List of waste dumps, disposal, treatment, and storage sites
 Agreements with any railroad, trucking, or other transportation company or courier
service
 Letters of credit
 Copies of any special benefits under contracts or government programs that might be in
jeopardy as a result of the proposed transaction (e.g., small business or minority set-
asides, intra-family transactions or favored pricing, internal leases or allocations, and so
on)
 Copies of licenses, permits, and government approvals applied for or issued to the seller
that are required in order to operate the businesses of the seller, such as zoning, energy
requirements (natural gas, fuel, oil, electricity, and so on), operating permits, or health
and safety certificates

f. Litigation and Claims, Actual and Contingent

 Opinion letter from each lawyer or law firm prosecuting or defending significant
litigation to which the seller is a party, describing such litigation
  List of material litigation or claims for more than $5,OOO against the seller asserted or
threatened with respect to the quality of the products or services sold to customers,
warranty claims, disgruntled employees, product liability, government actions, tort
claims, breaches of contract, and so on, including pending or threatened claims
 List of settlement agreements, releases, decrees, orders, or arbitration awards
affecting the seller
 Description of labor relations history
 Documentation regarding correspondence or proceedings with federal, state, or local
regulatory agencies

 Note: Be sure to obtain specific representations and warranties from the seller and
its advisors regarding any knowledge pertaining to potential or contingent claims or
litigation.

 Miscellaneous
 Press releases (past two years)
 Résumés of all key members of the management team
 Press clippings (past two years)

 Financial analyst reports, industry surveys, and so on

 Texts of speeches by the seller’s management team, especially if reprinted and
distributed to the industry or the media
 Schedule of all outside advisors, consultants, and so on, used by the seller over the past
five years (domestic and international)
 Schedule of long-term investments made by the seller
 Standard forms used (purchase orders, sales orders, service agreements, and so on)

The buyer’s acquisition team and its legal counsel gather data to answer
the following ten legal questions during the legal phase of due diligence:

1. What legal steps will need to be taken to effectuate the transaction (e.g., is director
and stockholder approval needed, or are there share transfer restrictions or restrictive
covenants in loan documentation)? Has the appropriate corporate authority been
obtained to proceed with the agreement? What key third-party consents (e.g., FCC,
DOJ, lenders, venture capitalists, landlords, or key customers) are required?

2. What antitrust problems, if any, are raised by the transaction? Will filing with the
Federal Trade Commission (FTC) be necessary under t h e premerger notification
provisions of the Hart-Scott-Rodino Act?
 3. Will the transaction be exempt from registration under applicable federal and state
securities laws under the “sale of business” doctrine?

4. What significant legal problems or issues are affecting the seller now or are likely to
affect the seller in the foreseeable future? What potential adverse tax consequences
to the buyer, the seller, and their respective shareholders may be triggered by the
transaction?

5. What are the potential post-closing risks and obligations of the buyer? To what extent
should the seller be held liable for such potential
liabilities? What steps, if any, can be taken to reduce these potential risks or
liabilities? What will it cost to implement these steps?

6. What are the impediments to the assignability of key tangible and intangible assets of
the seller company that are desired by the buyer, such as real estate, intellectual
property, favorable contracts or leases, human resources, or plant and equipment?

7. What are the obligations and responsibilities of the buyer and the seller under
applicable environmental and hazardous waste laws, such as the Comprehensive
Environmental Response Compensation and Liability Act (CERCLA)?

8. What are the obligations and responsibilities of the buyer and the seller to the
creditors of the seller (e.g., bulk transfer laws under Article 6 of the applicable
state’s commercial code)?

9. What are the obligations and responsibilities of the buyer and the seller under
applicable federal and state labor and employment laws (e.g., will the buyer be
subject to successor liability under federal labor laws and as a result be obligated to
recognize the presence of organized labor and therefore be obligated to negotiate
existing collective bargaining agreements)?

10. To what extent will employment, consulting, confidentiality, or noncompetition

agreements need to be created or modified in connection with the proposed
transaction?

6. BUSINESS AND STRATEGIC DUE DILIGENCE

Such varies according to the buyer, if the buyer is not in the same field of seller’s
company, the buyer will need in deep DD, while if it is a management buyout, such will
not need business and strategic DD but the focus will be on legal DD.
7. Questions to be addressed at early stage of acquisitions to
understand the seller’s activities
 The Seller’s Management Team
a. What are background and experience of key management  management cvs.
b. Has seller’s org. chart carefully reviewed and have the seller a management
functions and responsibilities delegated? --> authority and responsibilities.
matrix
c. What about the future growth of the market from which seller attracts the
employees? --> expected salaries growth
d. What are management team styles, strengths and weaknesses management
styles
 Operations of the Seller
a. production method: What are production method followed and is it protected
by contracts or similar
b. capacity utilization and risks: Capacity utilization and what are risk factors affect
the production such as RM along with the seasonality analysis and if the
production is based on that.
c. Fixed assets status: Assets operational efficiency and when should it be replaced
d. production plan and breakdown reports: Does the seller maintain production
plans, schedules, machinery breakdown records and other operational reports?
e. FG inventory status: Inventory status and when it will be obsolete and its
relation with sales cycle.
 Sales and Marketing Strategies of the Seller
a. Market form and market share: what is the seller’s primary and secondary
market, market size and market share as well as future expectation of the
market.
b. Competitors strengths and weaknesses: list of competitors and in what they
compete (price, quality, credits...etc.)
c. Customers types, location and factors affect demand: and to study contracts
with customers and if it may be improved
d. Current advertising and promotional campaign: and to follow if it is effectively
monitored and evaluated
 Financial Management of the Seller
a. Sales and income trends: what key sales, income, and earnings trends have been
identified? upon that the after acquisition impact to be forecasted whether
impacts on sales or costs (such upon the collected financial statement by legal
counsel)
b. Accounts receivables: what are billing and collection procedures and what is the
credibility of current customers and if the collection may be accelerated?
 c. Capital structure: what is current capital structure whether equity or debt
elements.
Due to several potential issues that may arise later and after acquisitions, the affidavit can be
customized to a particular transaction and include the specific concerns that may arise during the
transaction and afterward.
Below is model of affidavit
1. I am the sole shareholder of the S Corporation, which trades under the name
“SellerCo,” and I have full right to sell its assets as described in the Bill of Sale dated
_______________. Those assets are free and clear of all security interests, liabilities,
obligations, and encumbrances of any sort.
2. There are no creditors of SellerCo, or me, or persons known to me who are
asserting claims against me or the assets being sold, which in any way affect the
transfer to Prospective Buyer of the trade name SellerCo, its goodwill, and its assets,
including the equipment as set forth in the Bill of Sale dated _______________. I
agree to pay all gross receipt and sales taxes and all employment taxes of any sort
due through closing. I am current in regard to these taxes and all other taxes, and
there are no pending disputes as to any of my taxes or the taxes of SellerCo.
3. There are no judgments against SellerCo or me in any federal or state court in
the United States of America. There are also no replevins, attachments, executions,
or other writs or processes issued against SellerCo or me. I have never sought
protection under any bankruptcy law nor has any petition in bankruptcy been filed
against me. There are no pending administrative or regulatory proceedings,
arbitrations, or mediations involving SellerCo or me, and I do not know and have no
reasonable ground to know of any proposed ones or any basis for any such actions.
4. There are no known outstanding claims by any employees of SellerCo or me,
and I expressly recognize that no claims of, by, or on behalf of any employees arising
prior to closing are being transferred to Prospective Buyer.
5. There are no and have been no unions that have been or are involved in any
business that I own, and particularly, SellerCo. Furthermore, there currently is no
union organizational activity under way in any business that I own, and particularly,
SellerCo.
6. There are and have been no multi-employer pension plans or other pension or
profit-sharing plans involved in any business that I own, and particularly, SellerCo.
7. I have always conducted SellerCo according to applicable laws and regulations.
8. From the time when the purchase agreement was executed through closing, I
have conducted the business called SellerCo only in the usual and customary
manner. I have entered into no new contracts and have assumed no new obligations
during that time period.
9. I shall remain fully liable for payment of all bills, accounts payable, or other
claims against SellerCo or me created prior to closing. None of them are being
transferred to Prospective Buyer.
10. I hereby warrant and represent to Prospective Buyer that all statements in
paragraphs one through nine of this Affidavit are true and correct.
11a. I agree to indemnify and hold harmless Prospective Buyer in respect to any
and all claims, losses, damages, liabilities, and expenses, including, without limitation,
settlement costs and any legal, accounting, and other expenses for investigating or
defending any actions or threatened actions, reasonably incurred by Prospective
Buyer in connection with:
i. Any claims or liabilities made against Prospective Buyer because of any act
or failure to act of myself arising prior to closing in regard to SellerCo; or
ii. Any breach of warranty or misrepresentation involved in my sale of SellerCo
to Prospective Buyer.
11b. As to claims or liabilities against Prospective Buyer arising prior to closing in
connection with SellerCo, or any claim arising at any time in regard to any profitsharing
or pension plan started prior to closing involving SellerCo, or any breach of
warranty or other material misrepresentation made by me, I agree that Prospective
Buyer has the option to pay the claim or liability and deduct the amount of it from any
money owed to me, after giving me reasonable notice of the claim and reasonable
opportunity to resolve it. This right of setoff expressly applies to any damages
Prospective Buyer suffers as a result of any breach of any warranty I have given to
Prospective Buyer. Prospective Buyer’s right of setoff against any money owed me
shall not be deemed his exclusive remedy for any breach by me of any
representations, warranties, or agreements involved in the sale of SellerCo to him, all
of which shall survive the closing and any setoff made by Prospective Buyer.
12. I agree to execute any further documents to complete this sale.
Prospective Seller
 8. CONCLUSION
Due diligence must be a cooperative, involving both the
buyer’s and the seller’s teams.
Material misrepresentations or omissions can (and often do) lead to post-closing litigation
9. Post-Sarbanes-Oxley Due Diligence Checklist
Sarbanes-Oxley Act (SARBOX) or the Public Company Accounting Reform and
Investor Protection Act of 2002
The effect of Sarbox has been to compel investment banks, regulators, shareholder
groups, plaintiffs’ lawyers, and other parties to analyze companies with a focus on the
broad mandates of Sarbox.
Sarbox does not apply only to large publicly traded corporations; privately held
companies can also be subject to Sarbox. Lenders and customers can each require a
company to adopt Sarbox-style procedures.
The disclosures requirements: Regulation S-K, SFAS No. 5, and Sarbox
 Regulation S-K: issued by SEC and applied to public companies’ annual and
quarterly filings which encompass:
o Item 101: it is a descriptive to explain the business, the products, competition,
financial analysis of industry segments, R&D, foreign operations…etc.
o Item 103: include non-routine legal issues and material routine maters and
uncertainties that could have material impact on the business.
o Item 402: calls for detailed review of company’s executive compensation,
employee contracts, benefits, options and so on.
o Item 404: focus on related party transactions and any material contracts such
as leasing.
 SFAS No. 5: issued by FASB includes accounting for contingencies, so it is part of
complying with GAAP and must be reported by auditors. It requires a company to
establish a loss contingency when risk is probable and reasonably estimated.

 Sarbox:
o Section 302 of Sarbox: Requires CEO and CFO to certify some elements of
annual and quarterly reports being filled, such includes that they read the
reports and disclosures and certify that there is no material untrue issues
o Section 906 of Sarbox: upon which the senior officers can be subject to
potential criminal liability if they falsely, knowingly, or willfully make an
inaccurate Section 302 certification. Upon this provision the previous (302)
buyer’s CFO and CEO will provide post acquisition the required
confirmation, such is not possible if the DD was not handled properly.
o Section 404: a company has to establish and maintain adequate internal
control structures and processes to allow for accurate financial reporting.
 senior executives need to assess and report on the effectiveness of
these internal control structures and processes
 company’s auditors must provide an independent report on
management’s assessment.
  audit committees must enact whistle-blowing procedures to report
questionable accounting or auditing practices, As a result of Sarbanes-
Oxley, the duties of the audit committee have substantially increased.
A review of committee minutes often uncovers potentially important
issues. How the committee has resolved these issues may indicate its
effectiveness and independence.
The buyer should recognize the potential impact that this may have on the combined
company’s earnings

10. CHECKLIST OF ITEMS POST-SARBOX

a. Does the seller maintain effective disclosure controls and procedures?
i. are the disclosure controls consistently followed?
ii. does the seller have effective disclosure committee?
iii. Does audit committee and board committee pay attention to internal
control (check the records)?

b. Does the seller maintain effective internal control over financial reporting?

c. Are there any issues relating to the seller’s financial statements that are
significant enough to interfere with the ability of the buyer’s CEO and CFO
to certify SEC reports in the future?

NYSE VS NASDAQ: The largest difference is that the NYSE is an

auction market and the Nasdaq is a dealer market