Due Diligence For Buyers & Investors
Purchasing or investing in a business can be very quick to get started but expensive to reverse. Due diligence will help to verify if the vendors claims are true by checking against actual documents. This will ensure you are paying the correct amount.
The following guide shows buyers and investors in Pakistan what to look for in financial due diligence, tax, company and merger checks. We have also outlined how to conduct due diligence and what risks should prioritized. It also includes a financial due diligence checklist you can use before you commit.
Key Takeaways
- Due diligence will help you verify the sellers claims before you pay. This means you can move forward, re-negotiate or drop out.
- Financials are the most important. Ensure there is sustainable profits, actual cash, debt and any hidden liabilities. Use the financial due diligence checklist below to cover each one.
- Check Tax with FBR, Company information with SECP and if merger approval is required from CCP in Pakistan.
- Prioritize risks based on findings. Apply actions based on findings such as reducing the purchase price or getting a guarantee from the seller.
- Use a chartered accountant to help with the numbers and tax. Use a lawyer to help with contracts and legal ownership.
What is due diligence?
Due diligence is a systematic approach to verifying claims made by a seller. This will help you identify any risks and hidden costs. You can then decide whether to move forward, adjust the price or drop out.
If you are purchasing a company you will inherit the tax history, debt and disputes. If you are investing you are taking a smaller stake in the company however you are exposed to poor reporting and little control. Overlapping checks but different questions. Purchasers will want to know what they are inheriting whilst investors will want to know if the numbers are accurate and how well the owners are running the business.
Why is it important?
The price will usually be based on the numbers provided by the seller. If these aren’t accurate you could be overpaying from day one.
Due diligence will provide you with factual findings to use during negotiations. This can include reducing the price, holding back some of the payments or asking for guarantees on certain risks. Sometimes due diligence can show that the deal should not proceed, however this is a positive outcome as you will have avoided a bad purchase.
Types of Due Diligence
Most deals will require multiple checks.
| Type of Due Diligence | What to Check | Common Risk |
|---|---|---|
| Financial | Profitability, cashflow, debt, working capital | One-off profits |
| Tax | Tax returns, sales tax, withholding & notices | No tax returns filed or disputes with FBR. |
| Legal | Contracts, ownership, licenses & litigation | Key contracts which terminate on change of ownership. |
| Commercial | Customers, market & competition | Few customers contributing to most of the revenue. |
| Operations | Staff, systems, suppliers & assets | Reliant on one person. |
| Compliance | Licenses, SECP filings & industry compliance | Missing filings or expired licenses. |
Financial Due Diligence
Sustainable Profits
Check the accounts for the last 3-5 years. Strip out any one off profits and irregular costs to understand how much the business is earning in a typical year. This is often referred to by advisors as quality of earnings.
Cash Flow
Compare reported profits to bank statements & cashflow. Even if the business is profitable it may not have enough cash if customers are slow payers or they have high stock. Check working capital to understand how much cash they need each month. Working capital includes receivables, payables & stock.
Debt & Hidden Liabilities
Ensure you have a full list of any loans, guarantees, unpaid tax, supplier debts, staff debts & any claims outstanding. Check company documents to see if there are any charges registered against assets. Any issues which the seller hasn’t mentioned should be discussed in relation to price.
Price vs Adjusted Numbers
Compare the asking price to profitability, cashflow & asset value using the adjusted numbers. If due diligence has shown a change to the profits then this will impact the value. Use the adjusted numbers.
Buyer & Investor Financial Due Diligence Checklist
Use this financial due diligence checklist to collect the right documents from the seller.
- 3-5 Year Audited/Management Accounts
- Bank Statements to match revenue
- Customer & Supplier Debtors/Creditors by Age
- Stock Records & Stock take if applicable.
- Loan Agreements, Guarantees & Letters from Lenders
- Payroll & Any Staff Debt
- Budget & Forecast & Assumptions
- Relationship with Owners/Family/Other Companies.
Tax, Legal & Compliance Checks for Pakistan
Local regulations will impact the risk so we will cover these first.
Tax (FBR)
Ask for income tax, sales tax & withholding statements for recent years. Check for any notices, audits, appeals & unpaid tax. If you are buying shares then the company will inherit the tax history so any open tax issues should be addressed in price or contract.
Company (SECP)
Ensure Shareholders, Directors, Charges & Annual Filings are correct as per SECP.
Merger Approval (CCP)
Pakistan has a compulsory merger approval process set out by the Competition Act, 2010. This applies if the deal meets the criteria set out by the Competition Commission of Pakistan. This should be checked early on to avoid penalties if the deal doesn’t go through. The criteria can change so check with a lawyer or CCP for current figures.
Contracts & Licenses
Ask a lawyer to check key contracts with customers & suppliers, property documents, licenses & litigation. Check if any contracts will terminate or change on change of ownership. A chartered accountant will help with numbers & tax. A lawyer will help with legal ownership & contract issues.
How to Conduct Due Diligence on a Company
- Define Objectives & Scope What do you want to know? What is your budget & timescale?
- Sign NDA & Request List Ask for documents in a standard format.
- Review Documents Go through accounts, tax, contracts & documents. Highlight any missing information or discrepancies.
- External Verification Check bank details, official filings & if agreed with seller talk to customers/suppliers.
- Prioritize Risks Group findings by severity.
- Report & Decide Create a summary report. Consider how findings will impact the price & what assurances you want in the contract.
Risk Prioritization
Rate each finding based on likelihood & cost.
- High This could impact the deal or price. This could be a large tax liability or a key contract terminating. Renegotiate or drop out.
- Medium Cost is clear & manageable. This could be slow paying customers. Adjust price or add a payment condition.
- Low Minor issue which can be easily resolved. Flag up & resolve post deal.
Red Flags & Common Errors
Be cautious if you see any of the following:
- Seller is reluctant to provide documents.
- Numbers are changing between meetings.
- Profits look high but bank balances are low.
- Large amounts with owners other companies.
- Too reliant on one customer, supplier or person.
Most common errors are relying solely on the sellers documentation, rushing to meet a deadline, not checking tax & conducting due diligence after signing. Request a written report to ensure all findings are documented.
When to Use a Chartered Accountant
A chartered accountant can help verify accounts, strip back to real earnings, check tax exposure & help value the business using adjusted numbers. A chartered accountant can also work through this financial due diligence checklist with you. Find out how Muhammad Safdar FCA helps buyers & investors with financial checks on our due diligence services page. If your deal includes a merger or funding round please see our mergers & acquisitions page and transaction advisory page.
Read more about how investors assess IP during due diligence and why due diligence can help protect against fraud in business deals.
Ready to Check Your Deal?
Before purchasing or investing in a business ensure you have the numbers checked. Talk to Muhammad Safdar FCA about your deal, timeline & what risks you would like to check.
📍 71-C3 Gulberg III, Lahore, Pakistan
Frequently Asked Questions
Can I drop out after due diligence?
Yes. This will depend on the terms of the deal. Ensure you have an agreement in writing before due diligence starts.
What is the difference between due diligence and an audit?
An audit provides an opinion on if the past financial statements are a fair representation. Due diligence is specific to the deal and includes more checks such as contracts, tax, customers & risks.
How long does due diligence take?
This will depend on the size of the business & how quickly the seller provides documents. Smaller deals can take a few weeks whereas complex deals will take longer.
Who pays for due diligence?
Most deals will be paid for by the buyer/investor. However this can be agreed between both parties.
Do I need to complete due diligence for small deals?
Yes but in a simplified form. Even small purchases can have tax liabilities, debt & contract issues. Ensure you are checking to the same level as the size of the deal.
Can due diligence eliminate all risks?
No. Due diligence will help reduce any surprises by checking the available documents. However you cannot predict market changes & cannot uncover hidden facts. Due diligence should be combined with contract assurances.
