Financial Due Diligence

There’s wisdom in investigating a prospective business partner before investment

/ Finance / Financial Due Diligence

Financial due diligence is a key step in avoiding any last minute surprises that could derail a transaction

What is financial due diligence?

It’s wise for anyone who is entering an acquisition or agreement to first investigate the other party and its financial, operational and IT records and performance. This voluntary investigation or audit of a prospective business partner is what you call due diligence. Due diligence is a common practice among investors who are interested in acquiring or buying securities from certain companies.

For financial due diligence, CFOs, CPAs and accountants gather and analyze the quality and health of a potential target’s financial position, including earnings, working capital requirements, and free cash flow. In the due diligence should research whether the company has been involved in any lawsuit or corporate scandal. Recorded red flags should be considered by investors before doing any business with a particular company. Investors and advisors can also step up by checking and verifying credentials and background of the company’s management team.

Financial Due Diligence Checklist

The goal of using this checklist is to understand where the Company stands relative to each of the listed areas and items. Many of them will be “N/A” depending on the stage of the Company. These are many of the same issues that will be researched in either banking, equity or M&A due diligence and it’s best to know the answers early on.

For some of these items, the Company will be in good shape. Others may require a level of cost vs risk analysis to determine if it’s worth fixing now, or waiting until the Company is further along. In any event, doing this comprehensive review starts the Company on a path to being “Diligence Ready” and avoiding any last minute surprises that could derail a transaction.

Company Overview

  • Organizational Chart
  • Corporate Structure and Type of Corporation
  • Executive Team Bios
  • Strategic Plan
  • 3 and 5-Year Goals.
  • Competitor Analysis


  • State of Incorporation
  • Registered Agent
  • Registration and a Foreign Entity
  • Capitalization Table
  • Capital Structure
  • Common Stock / Preferred
    Stock / Warrants
  • Stock Option Plan and Awards
  • Profits Interest Plan and Awards
  • Operating Agreement.
  • Shareholder Agreement
  • Investor Documents (Series A, etc.)


  • Income Statement (Revenue, COGS, G&A, Sales & Marketing, R&D Expense)
  • Balance Sheet
  • Cash Flow Statement
  • Financial Model
  • Revenue Recognition Issues
  • Capitalized Software Policy
  • Capitalization of Assets Threshold
  • Goodwill and Intangibles Amortization Policy
  • Budget / Forecast
  • Financial Systems – Billing Systems
  • Banking
  • Credit Cards
  • Treasury Function
  • Monthly Reporting / Flash Reports + Dashboard
  • Approval Authorities / Tables / $ Thresholds
  • Non-Cash Compensation Expense Calculation / Black-Scholes Calculation
  • Audit Timing
  • New Customer Credit Application
  • Lease Arrangements
  • Royalty Arrangements
  • Related Party Transactions
  • Cash vs. Accrual
  • Financial Metrics – Margins, Days Sales Outstanding (DSO) etc.
  • Business Unit / Department Reporting with Executives
  • Business Metrics
  • Best Practice Review
  • SaaS Metrics
  • GAAP Checklist.

Sales & Marketing

Technology Due Diligence

  • Open Source Code List
  • Bugs Tracked List
  • Software License List
  • Roadmap
  • Product Management Software / Tracking
  • Intellectual Property Protection
  • Patents
  • IT Help Desk Support
  • Data Center
  • IT Security Policies and Procedures
  • Disaster Recovery Plan


  • Employee Agreements
  • Healthcare and Other Benefits Agreements
  • 401 (k) Plans and audits
  • ERISA Employee Handbook
  • Time and Expense Policies and Worksheet Compensation Philosophy
  • Stock Option Awards Distribution
  • Bonus Plans
  • Onboarding (Employee Application Form. New Hire Process. Job Requisition. Job Descriptions.)
  • Personnel Action Form
  • Code of Conduct
  • Performance Appraisal Forms
  • NonCompete Agreements
  • Non-Solicitation Agreements
  • Assignment of Intellectual Property Agreement.


  • Income Tax Returns
  • Sales Tax Returns
  • State Filings
  • City Business License / Property Taxes
  • Research and Development Credits
  • International Bank Accounts (FBAR)
  • Tax Elections
  • Nexus Issues
  • Form K-1 Dates
  • Form W-9’s
  • 83(b) Elections
  • FEIN
  • Transfer Pricing.

Board, Governance & Investors

Risk Management

  • Directors & Officers Liability.
  • Errors & Omissions
  • Professional Indemnity
  • Employee Practices Liability Insurance (EPLI)
  • Cyber Insurance
  • Umbrella Policy – Property and Casualty
  • Workers Compensation Insurance
  • Payment Card Industry (PCI) Compliance
  • Protected Health Information (PHI) Compliance
  • HIPAA Compliance.


  • Contract Management System
  • Non-Disclosure Agreements
  • Independent Contractor Agreements
  • Standard Sales Contract
  • Database of all signed Agreements, customers, vendors, partners, investors, other.

Debt Facilities

  • Types of Covenants
  • Reporting Deadlines


  • Payroll Service
  • Health Plan Vendors
  • 401(k) Vendor
  • Attorneys
  • Accountants/Auditors
  • Valuation Consultants
  • Investment Bankers
  • Lenders
  • IT Help Desk Provider
  • Data Center Provider and back-up
  • Key Partners.

Financial Due Diligence Process

Financial due diligence steps may vary depending on the type of investment and securities one would like to invest in. But in performing financial due diligence, all investors should first and foremost consider their risk tolerance. Below is the list of some of the financial due diligence steps to guide investors.

Scrutinize the Capitalization of the Company

Analyzing the market capitalization of a company gives investors an idea about a company’s scope of ownership and potential target markets. The stock price of companies with large capitalization tends to be less volatile due to its revenue trend and diverse investors. Meanwhile, companies with small capitalization and limited market share may have a more volatile stock price and revenue growth.

Know the Management and Share Ownership

Researching the members of the board and management of a company is a good determinant of investing. Bio and curricula vitae of the board and top management are published on the company’s website. Through this, one can see whether the people behind and running the company have experience and knowledge in the business. Investors might also want to look at the ownership of the corporation. If top officers have high stock shares, they tend to serve and run the company meticulously to serve their interests. They would ensure that the stocks of the company will consistently perform well in the market.

Calculate Valuation Multiples

Numbers do not lie. It is preeminent for any investor to utilize the various financial ratios in evaluating a specific company. Below are some of the financial ratios which can help investors before making any investment.

Price-to-Earning (P/E)
Price/Earnings to Growth (PEG)
Price-to-Sales (P/S)
Price-to-Book (P/B)

Examine the Balance Sheet

The Balance Sheet Statement shows the assets, liabilities, debts, and available cash of companies. Having a high amount of debts is not a red flag per se. What investors want to see is the amount of cash the company has to pay obligations and give as dividends. If a company has more cash, the more likely the investment will perform well.

Monitor Revenue and Profit Trends

The income statement will show any investor both the revenue and income of any company. Investors and financial advisors are interested in companies with recorded income historically, rather than losses. The monitoring of revenue, expenses, and equity trends of a company is vital before putting any investment in a company.

Determine Business Industries and Competitors

Looking into a company’s internal affairs before making an investment is not enough. An investor or financial advisor has the responsibility to evaluate the external environment of the company as well. It is vital to size up the competitors of a company by comparing its profit margins. This can help any investor determine whether the prospective company is competitive and profitable or not. On the other hand, performing due diligence on the industry will show investors if the business has opportunities for growth.

Research on the Stock Price History and Dilution Possibilities

For public companies, its important to know the short and long-term movements of the stock price. Most investors prefer stocks that have shown a steady price increase over time. Volatile stocks are often viewed as risky investments. Investors must also know if a company plans to issue more or dilute its shares, which may impact the stock price.

Due Diligence for Startup Investing

Investing in a startup or new company often entails higher risks compared to established corporations. Below are some of the strategies investors might want to consider when investing in a startup.

  • Choose a startup with products with a promising return on investment (ROI) within the next five years.
  • Evaluate the viability of the business to ensure an acceptable ROI.
  • Always have exit and divestment strategies in case the startup fails to ensure the recovery of your funds.
  • Consider partnership to split both the capital and risks.
  • Be ready to harvest your investment if you find that the business cannot survive new technology, trends, and policies.

Case Study

Questions? Call Us or Email

If you’ve never outsourced or used executives on demand before, you’re sure to have a lot of questions. Don’t worry, we’re more than happy to answer them all.
And we know everything there is to know about this unique model. Schedule a call with us or send an email now.