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SMB Twitter Legal M&A Masterclass - Session #9 (w/ Special Guest!)

SMB Legal M&A Masterclass
SMB Legal M&A Masterclass
Please see the Disclaimers at the very end of this article.
Session #9: An Introduction to Due Diligence
Introduction
Welcome to the ninth session of this no strings attached, completely free legal M&A masterclass. Special guest edition!
Today’s lesson is brought to you in part by Roman Beylin. Roman is the Founder of DueDilio, a concierge service designed to connect business buyers and private investors with quality, pre-vetted due diligence solutions.
Given Roman’s proximity to the SMB due diligence process, we thought it would be helpful to include some specific information on process, costs and other considerations.
For more information, links to the DueDilio website and Roman’s Twitter can be found here:
https://www.duedilio.com | https://twitter.com/RomanSB1
Please note that the author has no affiliation with DueDilio, is receiving no pecuniary gain or legal employment from DueDilio, and today's Session is not intended as an endorsement of DueDilio or any legal, financial or other advisors hired using DueDilio.

Session #9: An Introduction to Due Diligence
In the simplest terms possible, “due diligence” is the process of examining a potential acquisition or investment to obtain the business, legal and financial information of the target company necessary to determine whether to acquire or make an investment in the target company and, if so, on what terms.
What does this really mean? You’ve cleared the NDA stage, have agreed to the basic terms of the deal in your LOI, and now it’s time to lift the hood and have a look!
As a buyer, you will use the information gathered during the due diligence process to negotiate contractual protections, adjust the purchase price (or valuation), and provide information to lenders or other representatives.
The goals of due diligence are typically the following:
  1. Understand the target business
  2. Understand how the target business would integrate with existing businesses, if any
  3. Identify issues that would affect valuation
  4. Understand the risks associated with the target business in order to negotiate and draft the purchase agreement (including reps & warranties and indemnification)
  5. Identify any events that need to occur prior to closing (typically referred to as “conditions to closing”)
  6. Identify any actions that need to occur (or not occur) prior to or after closing (typically referred to as “covenants”)
For example, if your due diligence identifies any contracts, leases or licenses that require consent to assignment in the transaction, you’ll want to make sure those are conditions to closing!
In the end, due diligence should help you answer the most fundamental question regarding the proposed transaction:
Does it make financial sense and will it produce the intended results?
The Process
A buyer will typically conduct some due diligence before presenting the seller with their initial offer in an LOI. This will usually be limited to financial statements and other information necessary to complete an initial valuation of the business.
Once under LOI (or once you have an agreement in principal on major terms such as price), the first step is to provide the target company with a due diligence request list.
Practice Tip: It’s usually prudent to wait until you have a signed LOI (and exclusivity protections thereunder) to invest more than a nominal amount of money into due diligence fees and expenses.
Due Diligence Request List
Due diligence request lists are usually presented by subject matter and may contain the following categories:
  • Corporate Organization, Documents and History
  • Matters Relating to the Company’s Ownership and Securities
  • Financial Information
  • Customers and Suppliers
  • Real Property
  • Intellectual Property
  • Government Regulation
  • Litigation
  • Products Liability
  • Environmental matters
  • Insurance
  • Tax Matters
  • Employee Information and Documents
  • Other Material Agreements
  • Marketing Information
  • Data Privacy and Security
  • All Other Material Information
The specific information (and categories of information) that will be needed to conduct due diligence for your transaction will depend on the industry in which the target company operates, the size and sophistication of the target company, and other facts and circumstances. You should consult with an attorney or industry expert to prepare an appropriately tailored due diligence request list.
You should expect that due diligence will become a funnel! As you learn more about the target company, you will have more specific questions and document and information requests for the company. The process will be iterative and will take time!
The due diligence process is iterative and will result in more and more specific questions and document and information requests as you learn about the target company.
The due diligence process is iterative and will result in more and more specific questions and document and information requests as you learn about the target company.
In the end, you’ll never know everything about the target business.
And it will be years before you know the target business as well as the seller!
So, at some point, it will be necessary to take a “leap of faith” and rely on contractual protections* to do the rest!
*such as reps and warranties and indemnification, which we’ll cover later in the course
At some point, you'll have to take a "leap of faith," as there is only so much you can realistically learn about the target business.
At some point, you'll have to take a "leap of faith," as there is only so much you can realistically learn about the target business.
Guest Contribution - Roman Beylin of DueDilio
Due Diligence Costs & How to Assemble Your Due Diligence Team
I launched DueDilio in April 2021 with the goal of streamlining the M&A due diligence process. DueDilio is an expert marketplace connecting business buyers and investors with quality, pre-vetted due diligence service providers. Our deep network of independent professionals, boutique and mid-size firms, and subject-matter experts specialize in technology, finance, legal, operations, and other types of diligence projects. Our typical clients are searchers, independent sponsors, SMBs, and private investors pursuing deals in the range of $1M - $25M transaction value.  
Over the last 9-months, I have worked with over 95 clients helping them address their due diligence needs. Here’s what I learned about sourcing and pricing due diligence service providers:  
First, let me cover my...behind. The information I share below is high-level and mostly applies to standard transactions that I have seen. These costs and descriptions absolutely do not apply if you’re buying a multinational cryptocurrency trading exchange with 2k employees, 200k sqft of real estate, multi-currency assets, plus a laundromat business subsidiary based in Cyprus. ;)
With that disclaimer out of the way, let’s dive into it…
Financial Due Diligence
Financial due diligence is one of the most requested types of projects that we see at DueDilio.  
Here’s what we see most often:
Basic Financial Verification: Great if the buyer has experience in the industry and just wants a high-level review or second set of eyes to look over the numbers. Review a year or two of financials to spot any surface-level anomalies. Spot check business-specific financial metrics. Produce a high-level report highlighting any red flags. The most cost-effective solution is to hire an independent professional who has significant accounting experience. In some instances, this can even be produced by an offshore provider.
Cost: $1,500 - $4,000 
Standard Financial Due Diligence: Review at least three years of financial statements and produce a detailed report. Validate EBITDA, Proof of Cash Flow, and other financial metrics. Typically performed by CPA or accountant. Can be produced by an independent professional or a boutique firm. Some offshore providers can also produce this type of analysis.
Cost: $5,000 - $8,000
Quality of Earnings: This is one of the most detailed and time-consuming reports to produce. It is often required by lenders and/or investors. This is a comprehensive due diligence report including Proof of Cash, validation of key financial metrics, spot trends, and anomalies. The truth is that many independent professionals simply will not take on this type of detailed work and you may have to hire a boutique or mid-size firm.  
Cost: $8,000 - $25,000  
Business Valuation: There are many reasons why a business buyer or seller may want to request an independent third party business valuation. This can be performed by knowledgeable independent professionals as well as boutique and mid-size firms. 
Cost: $3,500 - $10,000
Legal Due Diligence
We have a lot of attorneys in our network and here is what we typically see for standard transactions that are < $15M.  
Entity Formation: Realistically, you should be able to do this yourself through Stripe Atlas, Mercury, Rocket Lawyer, or LegalZoom. If you do want help, an independent attorney would be the best and most cost-efficient option.
Cost: $500 - $1,500
Standard Deal Documents: This includes drafting of an LOI, Asset Purchase Agreement, Assignment and Assumption Agreement, and Bill of Sale. Typically will include a few revisions and one or two calls with the attorney. The most cost-effective solution is to hire either an independent attorney or a smaller firm with attorneys who have Big Law experience.
Cost: $2,500 - $25,000
Legal Due Diligence: Services performed can vary widely but typically include a review of merchant processing account, all corporate governance documents, secretary of state search, insurance review, and review of all employment/independent contractor agreements. Again, this can vary widely depending on the deal type and other factors.
Cost: $4,000 - $25,000
Technology
Website Due Diligence: Most relevant for content/affiliate/display websites, blogs, newsletters, and most media businesses. This analysis typically involves examining the website infrastructure, traffic, conversions, user acquisition, website structure, Google Analytics and Search Console, competitors, industry benchmarks, and other factors. This is a specialized type of analysis and should be performed by someone with the right background and experience. We have many independent professionals who can perform this.  
Cost: $100 - $1,000
Codebase & Tech Stack: This is most relevant for software and SaaS businesses. Typically includes a thorough review of the codebase, architecture, and infrastructure. The deliverable can be a simple red flag report or a more detailed analysis.  
Cost: $2,000 - $15,000
Cybersecurity: Especially important for finance, healthcare, or regulated businesses. Can include a simple review of policies and procedures to more hands-on penetration testing. Requires a very specialized skill set and someone with the proper certifications.
Cost: $7,500 - $25,000  
Other Types of Due Diligence
At DueDilio, we currently have 20+ types of due diligence that our service providers offer. I won’t list all of them but below is a quick summary of costs.
  • Deal Negotiation & Structuring: $500 - $2,000
  • HR/Benefits/Insurance: Free - $10,000
  • Sales/Marketing: $400 - $5,000
  • Logistics/Warehousing/3PL/Fulfillment: $5,000 - $10,000
  • Client/Employee Interviews: $80 - $200 per interview
  • Background Check: $500 - $1,500
  • Subject-Matter-Experts: $350 - $1,200 per hour
Questions? Just reach out for a FREE consultation with DueDilio.  
Assembling Your Due Diligence Team
DueDilio is a free platform that connects business buyers and private investors with quality, pre-vetted due diligence service providers. Before DueDilio, clients would have to spend several weeks researching service providers, collecting proposals, and finding the right solution. Today, the whole process can take as little as three business days. Simply go to our website and submit your project. Within two business days, we will present you with proposals from multiple service providers. After reviewing the proposals, we answer questions and connect you with the provider of your choice. 
DueDilio is free to use and there’s never an obligation to hire anyone.
For more information: https://www.duedilio.com 
Up Next in Session #10
Session #10 - Due Diligence - Review of Contracts and Corporate Records
Plus a Special Guest Contributor with his take on Business Due Diligence!
For More
For more from @SMB_Attorney or to stay up to date on this Legal M&A Masterclass, please subscribe below.
About @SMB_Attorney
I’m a senior corporate associate attorney for one of the world’s most elite law firms. 
I regularly work on transactions in the hundreds of millions to billion dollar plus range for some of the most recognizable companies in the world and have extensive experience with M&A.
The following is a link to my historical pinned tweet with more on me (to the extent you haven’t already been bored enough):
SMBAcquisitionAttorney
Trying my best to add value to SMB (Small and Medium-Sized Business) Twitter from a legal perspective. If you’re an SMB entrepreneur, search funder, acquisition entrepreneur, or otherwise interested in the SMB space, please follow along.

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Disclaimers
1. This course is being presented strictly for educational and informational purposes, and not for the purpose of marketing any legal services or seeking legal employment and is not motivated by pecuniary gain.
2. The opinions stated in this course or any tweet from @SMB_Attorney represent the opinions of the author and not the opinions of any other person or organization.
3. Nothing contained in any tweet or otherwise from @SMB_Attorney during this course or otherwise is to be interpreted as legal, financial, tax, investment and/or any other form of advice. Please consult your own legal, financial, tax, investment and/or other advisors.
4. @SMB_Attorney is not your lawyer, and no information provided in the course of this class or otherwise has the affect of forming an attorney-client relationship between you and @SMB_Attorney. In short, get your own lawyer! 
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