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Appendix D
Due Diligence Examination Outline
The goal of due diligence is to understand fully In view of the above, the following outline should
the business of the issuer, to identify the risks not be considered a definitive statement of, or a
and problems it will face, and to assure that the standard recommended by, NASD Regulation
registration statement is complete and accurate. regarding the due diligence issues and procedures
Thoughtful analysis concerning the particular that would be required or appropriate in any
issuer as well as the experience, knowledge and particular initial public offering.
care of the underwriters and their counsel in
this process represent the critical ingredients of I. Before Commitment Is Made to Establish
due diligence. A checklist of topics and Investment Banking Relationship With
procedures merely serve as an aid in the due Prospective Investment Banking Client
diligence process when used in conjunction (the “Company”)
with thoughtful analysis and the review of
A. Staffing the Review
applicable registration forms, rules and guides
promulgated by the SEC. 1. Assign personnel who have particular
competence in the business in which
The SEC and NASD Regulation both have the issuer is engaged.
acknowledged that attempts to define or 2. Consider retaining outside
standardize the elements of the underwriters’ consultants to analyze the technology
due diligence obligations have not been employed by the Company and others
successful. The appropriate due diligence in the Company’s industry.
process will depend on the nature of the issuer,
the level of the risk involved in the offering, and B. Assessing Integrity of Management
the investment banker’s knowledge of and 1. Inquire of appropriate parties
relationship with the issuer. whether the corporation is being run
by the type of persons with whom the
Checklists of the items to be covered in a due investment banker would wish to be
diligence investigation can be useful tools. It is associated.
not possible, however, to develop a checklist that 2. Determine whether any of the
will cover all issues or all offerings. Due diligence Company’s officers, directors, or
is not a mechanical process. The use or absence principal shareholders have been
of use of a checklist does not indicate the quality charged or convicted of any charges
of due diligence. Conversely, deviation from any involving fraud, embezzlement,
checklist that is used does not taint a due insider trading, or any other matter
diligence review any more than the following of concerning dishonesty.
a checklist validates such a review.
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C. Review of Industry 3. Transactions with the companies.
1. Examine prospectuses, Form 10-Ks, 4. Past and present occupations.
and annual reports prepared by other 5. Record and beneficial ownership of
corporations in the industry. the stock.
2. Examine research reports on major 6. Compensation, direct and indirect.
corporations in the industry as well as 7. Principal shareholders.
reports on the industry itself.
8. Knowledge of pending or threatened
3. Become familiar with applicable litigation.
regulations governing the industry.
B. Submission of Request
4. Study the accounting practices
for Company Documents
followed in the industry, including
any differences in accounting practices 1. Regarding legal status.
followed by different companies. a. Charter documents (articles of incor-
5. Determine financial ratios of the poration and bylaws) and all
industry as a whole. amendments.
6. Become acquainted with new b. Minute books for meetings of
developments in the industry by directors, shareholders, executive
examining trade publications. committee, stock option committee
and the like for the past five years.
7. Determine the industry size and
growth rate. c. Copies of applications for permits to
issue stock permits, and exemption
8. Assess whether the industry is subject
notices.
to cyclical influences.
d. Specimen stock certificates.
9. Determine whether seasonality of
demand affects the industry. e. Copies of voting trust and voting
agreements.
10. Determine the stage of the industry in
the industry life cycle (e.g., growth, f. Documents previously filed with the
maturity). SEC, including prospectuses, Form 10,
10-K, 9-K, 8-K, proxy statements, and
11. Evaluate short-term and long-term
supplementary sales literature.
prospects for the industry.
g. Contracts or arrangements restricting
II. After Commitment is Made to Establish the transferability of shares.
Investment Banking Relationship h. Shareholders’ list indicating names,
ownership, and how shares are held.
A. Submission of Questionnaire
i. Licenses to conduct business.
to Officers and Directors
j. Foreign qualifications, if any.
The specific information to be sought
includes: k. All documents filed with any state
agency affecting corporate status,
1. Relationship to underwriters.
including annual reports.
2. Voting arrangements.
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Appendix D: Due Diligence Examination Outline
2. Regarding the Company’s business. registrations, trade secret agreements
a. Promissory notes (except immaterial and any opinions of counsel related
routine notes from persons, other than thereto.
officers, directors, or 10 percent l. Distribution or agency agreements.
shareholders), loan agreements, trust m. Consignment agreements.
deeds, indentures and all relevant
n. List of major customers and suppliers,
correspondence regarding same.
copies of their existing agreements,
b. Financial statements and tax returns and copies of correspondence for the
for the past five years. past year.
c. Stock option agreements, profit o. All documents relating to any
sharing and pension plans, supple- complaints, investigations, claims,
mentary information booklets. hearings, litigation, adjudications, or
d. Annual reports. proceedings by or against the
e. Advertising materials, brochures, and Company, including copies of the
other sales literature. material pleading.
f. Leases and/or grant deeds. p. All documents relating to issuance of
stock, including offering documents
g. Description of plants and
and documents relating to reliance on
properties.
securities registration exemptions and
h. Agreements with officers, directors, any related litigation action or
shareholders, or promoters (e.g., proceeding.
employment agreements,
q. Business plans (past five years).
indemnification agreements).
r. All written documents relating to
i. Documents of agreements with
employment policies and practices.
affiliates (e.g., lease, purchase
agreement, license, covenant not to s. All correspondence between the
compete, etc.), insiders and other Company and legal counsel regarding
related parties, and if affiliate is other responses to requests for auditors
than a natural person (e.g., trust, information (for five years).
estate, partnership, joint venture, t. Copies of any pleading or other
corporation) court orders, agreements, documents relating to any litigation,
stock book, and other documents action, or proceeding related to any of
necessary to establish precise nature of the Company’s affiliates, officers,
affiliation and terms thereof. directors, or beneficial owners of 10
j. All materials contracts. percent or more of stock.
k. Copies of licenses, permits, u. All insurance documents.
governmental approvals, quality v. Affirmative action plans.
ratings, franchises, patents, copyrights, w. Any other documents that are material
trademark and service mark to the Company.
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C. Review of Basic Corporate Documents 4. Evaluate restrictive covenants.
1. After gaining an understanding of the a. Examine indentures and loan
industry, examine specific Company agreements.
documents filed with the SEC during the b. Consider the effect such covenants
past five years, including: might have on the Company’s
a. Form 10-K. operations and prospective financing.
b. Form 8-K. D. Analysis of the Company and its Industry
c. Form 10-Q. 1. Company analysis.
d. Registration statements and private a. Compare the Company’s prior
offering memoranda relating to the business plan and financial plan with
sale of securities and any the actual results obtained.
e. Proxy statements for: b. Determine the Company’s principal
1) Annual meetings, product lines. If the Company’s
2) Acquisitions, and principal products are newly developed,
it may be desirable to retain an
3) Other transactions requiring a
independent consultant who can advise
shareholder vote.
on the technology, the feasibility of the
2. Examine document and other product, and its potential market.
communications sent to the shareholders
c. Examine the demographic and
during the past five years, including:
geographic markets in which the
a. Annual reports and quarterly reports, company sells its products.
with particular attention to the
d. Compile a list of principal customers
president’s letter, which may provide
by products.
insight into any major problems faced
by the corporation. e. Obtain samples of marketing and sales
literature used for various products.
b. Follow-up reports on annual
meetings. f. Determine the mechanism for distri-
bution of company products or
c. Shareholder letters.
services, i.e., wholesale and
3. Examine public documents on the retail distributors, personal service,
Company. or Internet.
a. News clippings. g. Assess the technology position of the
b. Press releases. company.
c. Documents on file. h. Compile a list of trademarks, trade
d. NEXIS computer searches. names, and service marks and assess
the protection obtained for such marks
e. Recent private placement
and names.
memoranda and written rating agency
presentation. i. Obtain copies of permits for conduct of
business, including licenses, franchises,
concessions, and distributorship
agreements.
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Appendix D: Due Diligence Examination Outline
2. Strategic analysis. (4) Profitability ratios.
a. What are the Company’s long-term (a) Return on assets.
goals? (b) Return on equity.
b. On what basis does the Company (5) Price-earnings ratios.
measure its performance?
4. Prepare a written memorandum setting
c. What strengths does the Company forth questions to be asked of
intend to exploit to be successful in its management and areas to be explored in
industry? greater depth.
d. What weaknesses does the Company
have in the industry and what does it E. Visits to Principal Facilities
intend to do to overcome such 1. If the Company is a manufacturing
weaknesses? concern, visit one or more of its principal
e. What are the current market opportu- plants. Inspect the facilities to become
nities and how does the Company acquainted with the Company’s products
plan to exploit such opportunities? and the manner in which they are
produced.
f. What are the risks that the Company
faces in the industry? What is the 2. If the Company is not a manufacturing
likelihood that such risks will come to concern, visit one or more of the
fruition? What would be the Company’s offices to obtain an overview
consequence to the Company if the of the Company’s day-to-day operations.
risks came to fruition? 3. Does it appear the facilities are being fully
g. What are the Company’s business utilized?
strategies for success in the industry? F. Meetings with Principal Officers (after
3. Financial analysis. reviewing the registration statement but
a. Compare basic financial ratios of the before engaging in a line-by-line discussion
Company to the industry average. of the document)
(1) Debt to equity ratios. 1. Hold individual meetings with executive
officers responsible for significant aspects
(2) Liquidity ratios.
of the Company’s business.
(a) Current ratio (Current
a. Prepare a list of questions in advance to
assets/current liabilities).
focus the discussions.
(b) Quick ratio (Current assets
(1) How would you assess the flexibility
minus inventory/current
of the production facilities?
liabilities).
(2) Do you anticipate advances in
(c) Earnings/fixed charges.
production techniques and, if so, is
(d) Price/earnings ratios.
the Company prepared to make
(3) Asset utilization ratios. such advances?
(a) Sales turnover.
(b) Total assets turnover.
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(3) Does the Company have any (16) Has the Company lost any major
continuing obligations in connection customer, supplier or distributor
with sales, such as an ongoing within the last five years?
maintenance and repair obligation or If so, why?
a requirement to finance purchases (17) Are any of the existing shareholders
by customers? antagonistic toward the current
(4) How do you assess the quality and management of the Company? If
quantity of resources allocated by the so, please explain.
Company to research and b. During the course of the interviews,
development? ask the same questions of different
(5) What are your financial projections? corporate officials to evaluate the
(6) Have results met past projections? answers received and to obtain
different perspectives on potential
(7) How do you assess the gross profit
problems.
margin trends in your various
product lines? 2. Hold at least one meeting with the
Company’s chief executive officer (CEO).
(8) How do you feel about the level of
sales for each of the Company’s a. Ask the CEO to review the broad
product lines? aspects of the Company’s strategic and
operational goals and its plan to
(9) How do you assess labor relations?
achieve those goals.
Have there been any work stoppages
and, if so, how have you dealt with b. Ask the CEO for his or her personal
them? assessment of the Company’s strengths
and weaknesses.
(10) What is the Company’s overall
advertising and marketing plan? (1) This interview should be as far
reaching as circumstances warrant.
(11) What is the Company’s acquisition
policy? Explain the Company’s recent (2) It is essential to listen critically to
acquisitions, if any. the CEO’s comments.
(12) For what does the Company plan to 3. Based on the meetings, assess the
use the proceeds of the public competence of the officers of the
offering? Company.
(13) How would you assess the inventory a. Are the administrators organized and
turnover? knowledgeable?
(14) Have there been any delays in new b. Are the financial officers skilled?
product introduction? c. Are the technical personnel well-
(15) Has the Company changed qualified?
accounting or legal representation d. Is the management structure such that
within the last five years? If so, why? it can adjust to the Company’s growth
beyond the current stages of operation?
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Appendix D: Due Diligence Examination Outline
G. Meetings with Company’s I. Meetings with Other Third Parties
Accountants (Out of the Presence 1. Suppliers/creditors/distributors. Does the
of the Company’s Officials) Company pay its bills/debts in a timely
Questions to Ask: manner?
1. How would you assess the Company’s 2. Competitors and customers.
internal controls? a. What is the company’s reputation?
2. Are there any unusual accounting b. How would you rate management’s
issues in regard to the Company or the reputation?
industry?
c. What risks are present in the Company
3. Are reserves adequate? and its industry?
4. How would you assess the Company’s d. How would you rate the quality of the
aged-analysis of accounts receivable? Company’s products and services?
5. Do you note any unusual fluctuations
in inventory? J. Legal Review
6. Is the Company’s method of revenue 1. Review of basic corporate documents.
recognition in line with industry a. Articles of incorporation.
practice and applicable accounting (1) Obtain copies of the articles of
principles? incorporation, including any
7. How do you assess the Company’s restated articles and amendments.
segment reporting? (2) Determine whether all of these
8. From your dealings with the items were certified by the Secretary
Company’s accounting and financial of State (by whatever name known)
personnel, how would you assess their of the state in which the company is
capability? incorporated.
(3) Determine whether the purposes
H. Meeting with Company’s Counsel
clause of the articles is broad
Questions to Ask: enough under the applicable law to
1. How would you assess the pending include all actions previously taken
litigation and contingent liabilities of and presently being contemplated.
the Company? (4) List the dates of all amendments
2. How would you assess the pending and summarize changes.
administration and regulatory (5) Were such amendments validly
proceedings that the Company is facing? authorized by the shareholders?
3. How would you assess the status of the (6) Is the name as specified in the
Company’s proprietary information Charter the same as used by the
and intellectual property, including any Company?
copyrights, trademarks, service marks
(7) Do the powers of the Company
and trade secrets?
suggest any restrictions?
(8) Is the authorized capital sufficient?
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(9) Verify the description of the Company’s (3) Indicate whether the Company
equity stock. holds regular periodic meetings of
(10) Do the articles provide for preemptive its directors.
rights? (4) What is the normal frequency of
(11) Does the authorized number of such meetings?
directors conform to the minutes? (5) Were notices duly given or waivers
(12) Do the articles provide for the accessi- obtained with respect to these
bility of shares? meetings? If so, indicate whether
such waivers were actually signed
(13) Do the articles provide for restrictions
before or during the meetings, or
on issuance of shares?
whether they were executed after
(14) What is the county of the principal the meetings.
place of business?
(6) If a meeting was not held, were
(15) Do the articles provide for indemnifi- resolutions adopted pursuant to
cation of officers and directors? proper unanimous written consent?
b. Bylaws. (7) Prepare a summary of the minutes
(1) Obtain copies of the bylaws, including for review by the underwriters.
all amendments certified by the d. Meetings.
corporate secretary.
(1) Indicate the date and place for
(2) Review for powers of officers, roles of meetings, both for directors and
committees, powers to amend, restric- shareholders, as provided in the
tions on actions, and other governing bylaws or articles of the
provisions. corporation.
c. Minutes. (2) What were the actual locations of
(1) Obtain minutes of all meetings of the last three shareholders’
directors, committees of directors and meetings?
shareholders, including copies of any (3) What were the actual locations of
written notices, waivers of notices, and the last two directors’ meetings?
written consents to action without a
e. Executive committee meetings.
meeting, all for the past five years.
(1) If the Company has an executive
(2) Has the Company regularly held its
committee, does it hold regular
annual meeting of shareholders? If not,
periodic meetings?
explain the circumstances. If not, were
notices duly given or waivers obtained? (2) If so, are minutes regularly
If notices or waivers were properly prepared?
obtained, indicate whether such waivers (3) If such minutes are prepared, is
were actually signed before or during such preparation under the
the meetings, or whether they were direction or approval of the office
executed after the meetings. of general counsel?
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Appendix D: Due Diligence Examination Outline
(4) If no meetings are held, are (3) Who is the stock transfer agent for
resolutions properly adopted the Company? (Indicate the
pursuant to unanimous written transfer agent’s complete address.)
consent? i. Annual reports.
f. Directors’ and shareholders’ (1) Obtain copies of any document
meetings/minutes. sent to shareholders, including the
(1) How are the corporate minutes Company’s annual reports,
and/or unanimous written quarterly reports, following reports
consents kept? If the minutes or on annual meetings and
consents are kept looseleaf, are the shareholder letters and press
pages consecutively numbered? releases sent within the last three
(2) Are previous minutes of meetings years.
properly signed? Who signs the j. Proxy statements.
minutes? (1) Obtain copies of any proxy
(3) Do all previous minutes reflect the statements of the Company for
presence of a quorum and the annual meetings, acquisitions or
names of those in attendance? other transactions requiring a
(4) Do all previous minutes indicate shareholder vote within the last
the approval of previous minutes? five years.
(5) Do all previous minutes indicate (2) Obtain copies of the form of proxy
the time and place of the holding used for the last annual meetings.
of the meeting? k. Annual certified audits.
(6) Do all previous minutes indicate (1) Obtain copies of the annual
that either waivers were properly certified audits of the Company for
executed or notices properly given the last three years, if any, unless
for the meeting? contained in the annual report.
g. Voting trust agreements. (2) Has there been any change in the
(1) Obtain copies of any voting accountants?
trust agreements, or l. Election procedures.
shareholders’ or similar (1) Do election procedures for
agreement, and lists of the directors, as used by the Company,
shares covered. comply with all applicable laws and
(2) Do such agreements terminate by regulations, including the
virtue of the offering? Company’s bylaws?
h. Minute books and stock records. (2) Have directors been unanimously
(1) Where are the minute books of the elected?
Company physically kept? m. Concurrent director/officer status.
(2) Where are the stock record books (1) Was any person who was both a
of the Company physically kept? director and an officer present at
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the meeting at which his or her salary (2) Is the indemnification agreement or
was set? policy authorized by applicable
(2) Was such person counted as part of the jurisdiction?
quorum for such a meeting or did that (3) Is any indemnification in the
person sign a unanimous written consent bylaws consonant with law in the
for same? applicable jurisdiction?
(3) If an affirmative answer is given to q. Rights of the various classes of stock.
either (1) or (2), does such action create (1) State the voting rights of the
a legal problem under the applicable various classes of stocks.
law?
(2) Are any dividends on preferred
n. Power of board of directors. stock presently in arrears? If so,
Is it the Company’s policy to get the board indicate any additional preferences
of directors’ approval for: that come into being because of the
(1) Changes in reserves? arrearage.
(2) Changes in surplus accounts? (3) Indicate any potential voting right,
(3) Declaration of dividends? other than noted in Section II.J.1.b.
above, held by holders of preferred,
(4) Election of officers?
convertibles, debentures, bonds,
(5) The setting of officers’ salaries and/ etc., that become effective on the
or bonuses? happening of contingent events
(6) Amendments to the by-laws of the (such as failure to pay dividends or
corporations? make payments).
(7) The granting of powers of attorney? r. Dividends and other distributions
o. Policy-making authority of the board of (1) Indicate the Company’s dividend
directors. record on common stock for the
(1) As a practical matter, does the past five years.
Company get the board of directors’ (2) Indicate any other distribution of
approval for all major policy decisions? property to shareholders by the
(2) If not, how much leeway does the board Company over the past five years.
of directors give the Company’s (3) Has the Company ever paid a
management in the area? dividend or made another distri-
p. Indemnification. bution to shareholders without
meeting an earned surplus or other
(1) Obtain copies of any insurance policies
test under applicable state law to
or other agreements, other than the
cover it? If so, explain.
bylaws of the articles of incorporation,
which provide for the indemnification s. Pension plans/profit sharing
of any officer, director, shareholder, plans/stock option plans.
employee, or other agent of the
company.
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Appendix D: Due Diligence Examination Outline
(1) Obtain copies of (i) all pension plans, (3) Is the Company licensed to
(ii) all profit sharing plans, and (iii) do business in any states in which it
all stock option plans. presently is not doing business? If
(2) If the Company has a pension plan, so, indicate the tax consequences
indicate the date on which there last for each jurisdiction.
was a compliance with the Federal x. Corporate opportunity doctrine
Pension Plan Disclosure Act. compliance.
(Compliance is obtained by giving a (1) Indicate any possible violation of
printed copy of the plan to the the corporate opportunity doctrine
employees covered thereby.) known to the Company’s counsel.
t. Reports filed with governmental agencies. y. Contingent liabilities.
(1) Review all material reports filed with (1) List all material contingent
any governmental agency (state or liabilities of the Company not
federal) during the last 12 months. otherwise set forth in this audit.
(2) Indicate whether the narrative in all 2. Documents regarding securities.
reports filed with any governmental
a. Stock options/stock purchases/
agency, as well as the Company’s
stock bonuses.
annual report, is checked for accuracy
by the office of general counsel. (1) Obtain all forms of stock option
plans, stock purchase plans, and
u. Related parties.
stock bonus plans, and all forms of
(1) Does the Company do business with stock option agreements, or escrow
which any officer or director, including agreements that have been or may
spouses and other close relatives, has be used under any such plan, as
an interest? well as all other documents relating
v. Insurance. to the issuance of securities by the
(1) Is the Company self-insured? Company, including other purchase
agreements, registration rights
(2) If so, to what extent?
agreements, and offering circulars.
(3) Indicate the insurance coverage of the
b. Sources of capital.
Company, giving the name of the
carrier and the policy numbers of (1) List each issue of stock, bonds,
each type of coverage. debentures, options, warrants, other
convertibles, etc., indicating the
w. License to do business.
amount, the authorized amount,
(1) Indicate the states in which the and the applicable permit or regis-
Company does business. tration of each (both state and
(2) Obtain copies of certificate of good federal), and if there is no permit
standing to determine if the and/or registration, state the
Company is properly licensed in each claimed state and Federal
state it is doing business. exemption.
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(2) List the states where such securities (1) Obtain bank lines of credit
described in Section J.2.a., above, agreements, including any
were issued and state the date of amendments, renewal letters,
blue-sky authorization. If no such notices, default waivers, etc.
authorization, give the applicable (2) Obtain other outstanding loan
exemption. agreements, guarantees, indentures,
(3) Indicate the date of each federal or agreements with respect to
registration, if any, and the term indebtedness.
for which registered. (3) Obtain all outstanding material
(4) Obtain copies of any agreements leases for real and personal
pursuant to which such securities property.
were issued (e.g., stock option (4) Obtain material contracts with
plans, underwriting agreements, suppliers and customers.
placement agreements, bond
(5) Obtain any model sales contracts,
indentures, etc.).
license agreements, and dealer
(5) Do any such agreements provide agreements used by the Company.
for registration rights? If so,
(6) Obtain agreements for loans and
describe.
any other agreements (including
(6) Obtain copies of all applications consulting and employment
for permits, private placement contracts) for officers, directors, or
memoranda and registration employees, whether or not now
statements. outstanding.
c. Payments for stock. (7) Obtain schedule for all insurance
(1) Do the Company’s records indicate policies in force covering property
all of its outstanding stock was of the Company and any other
properly issued for value? insurance policies, such as “key
(2) Is any of the Company’s stock not man” policies or products liability
fully paid? If so, explain; do statutes, policies.
articles and by-laws permit? (8) Obtain partnership or joint venture
d. Stock issuance/transfer restrictions. agreements.
(1) Do all issuance and transfers (9) Obtain copies of any bonus plans,
comply with any rights of first retirement plans, pension plans,
refusal, preemptive rights, or other deferred compensation plans, profit
restrictions contained in the sharing and management incentive
articles, bylaws or other agreements.
documents, such as placement b. Mortgages, notes payable, and
agreements? other liabilities.
3. Review of material contracts. (1) List all mortgages (including deeds
a. Various material contracts. of trust) of the Company on which
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Appendix D: Due Diligence Examination Outline
the anticipation is that final payment doing business with specified
will not be made within the 36 nations or limitation on certain
months of the date of this trading, such as trading in gold and
examination. foreign exchange.
(2) Indicate whether such mortgages (2) What steps have been taken to
overlap any other security interest ensure that the Company does not
given by the Company. violate any prohibitions concerning
(3) List all notes and other liabilities in transactions between designated
excess of $5,000. foreign companies or concerning
transfer with respect to securities
c. Reports on dividends.
registered in the name of
(1) Does the Company make reports designated nationals, as well as
(both federal and/or state) on importation of and dealing on
dividends paid to its shareholders? certain classes of merchandise?
(2) If so, give the date of the last such (3) List all corporations incorporated
report. in a foreign country in which the
d. Corporate negotiable insurance. Company owns 10 percent or more
(1) Indicate each institution in which the of the capital stock, and for each
Company has authorized its agents to such corporation indicate (i) any
execute negotiable instruments, outstanding powers of attorney (ii)
showing the authorized agents, their any guarantees undertaken (iii) any
titles, and the limit of their authority. liabilities created, and (iv) and
contract commitments undertaken.
(2) For each of the authorizations,
indicate the date of the corporate g. Prepaid items.
resolution authorizing the signature. (1) List all prepaid items on the
e. Authority of corporate agent. Company’s book of assets when
such prepayments exceed $100,000
(1) Is a notice of limit of agent’s
and will continue in excess of this
authority given to each new account
amount for more than 12 months.
with which the Company does
business? h. Bad debts.
(2) If not, what steps are taken to ensure (1) Indicate the percentage of accounts
that each agent of the Company does receivable that became bad debts in
not exceed his/her authority? each of the last three years.
f. Business outside the United States. (2) Ascertain trends regarding
bad debts.
(1) If the Company does any business
outside the United States, determine i. Security interests.
whether or not any activities of the (1) What security interest, if any, is
Company might reasonably be typically used to secure open
construed as a violation of any accounts?
statutory or regulating limitation on
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(2) Are such security devices properly premises currently being paid less
perfected? than the applicable minimum wage
(3) In how many states does the Company per hour? If so, what justification
presently have perfected security can be given for a lower rate of pay?
interest? (3) Are any employees covered by a
(4) What steps are taken to ensure state minimum wage law requiring
the timely filing of continuation the payment of more than the
statements required under Article 9 of federal minimum wage per hour? If
the Uniform Commercial Code? so, indicate with appropriate
citation the state law, the bargaining
j. Warehousing.
units covered, and any other
(1) Does the Company, as either buyer or pertinent information.
seller, utilize the facilities of on-premises
(4) Is overtime paid? If not, explain
warehousing for financing purposes?
when it is not paid.
(2) Does the Company, as either buyer or
n. Child labor.
seller, utilize warehouse receipts in
financing? (1) Does the Company employ any
person under eighteen years of age
k. Labor contracts.
on a permanent basis?
(1) List all labor contracts to which the
(2) What safeguards are taken to ensure
Company is a signer, indicating the
that the Company does not violate
bargaining unit covered, the union, the
either the federal or state “Child
termination date, and a general
Labor Act”?
statement of the company’s relationship
with the union, indicating specifically o. Compliance with fair labor standards.
any major problem areas. (1) Has any governmental agency
(2) If there are material problems, obtain checked the Company within the
copies of each labor contract. last three years in regard to
compliance with the fair labor
l. Individual employment contracts.
standard act or other litigation
(1) Does the Company have any individual regarding employees?
employees with a written employment
(2) If so, indicate the approximate date
contract?
and result of the investigation.
(2) If so, obtain copies of all forms used for
p. Compliance with antidiscrimination
employment contracts (including forms
statutes.
of contracts used for executives).
(1) Does the Company have procedures
m. Minimum wage compliance.
to assure compliance with antidis-
(1) Is the Company considered to be criminatory statutes relating to age,
engaged in interstate commerce? sex, and race; and does it keep
(2) Are any employees or employees of adequate records to demonstrate
subcontractors working on the compliance (e.g., application forms,
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Appendix D: Due Diligence Examination Outline
records of employees, and work (2) Make a schedule of all leases for
assignments, etc.)? real and personal property
(2) Does the company, in fact, have an requiring payment of a material
age limit cutoff beyond which amount.
general hiring is not done? If so, what u. Contract forms and significant
is the age limit? provisions.
(3) What steps have been taken to ensure (1) Do the contract forms presently in
the compliance by the Company with use by the Company meet the
federal statutes prohibiting age requirements of the Uniform
discrimination in hiring? Commercial Code?
q. Salary withholding information. (2) What precautions are taken to
(1) Does the Company maintain an up- ensure that, upon acceptance,
to-date file of Form W-4 additional terms are not inserted by
(withholding information) for each the other party and made part of
employee? the agreement?
(2) Has the Company failed to comply (3) Obtain copies of all significant
with withholding requirements? contract forms utilized by the
Company.
r. Worker’s compensation.
(4) Are any required anti-discrimi-
(1) Does the Company maintain the
nation provisions included?
worker compensation insurance
required by the state on each v. Current breaches of material
employee? agreements.
(2) If not, explain. (1) If any party is presently in breach of
any material agreement with the
s. Other. Assess compliance with state and
Company, indicate:
Federal laws related to the environment,
occupational health and safety, and (i) the default,
antitrust/unfair trade practice (ii) the contract penalty for the
regulations. breach, if any,
t. Material payments on contracts. (iii) what action presently is
(1) List all contracts, presently in force, being taken and
on which the Company, directly or (iv) what action is being
indirectly, is bound, that will not be contemplated.
completed within 24 months, and (2) Does the Company take action in
each that involves payments (or the event of breaches by others?
performance of services or delivery
w. Sales of the Company’s products.
of goods) to or by the Company of a
material account. (1) Indicate how the Company’s sales
are made (i.e., through sales agents,
distributors, independent
contractors, etc.).
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(2) Indicate the authority each type of (3) List those jurisdictions on which
selling agent possesses. direct sales are made only via
(3) If sales agents have limited authority, communications in interstate
what steps are taken to publish this commerce.
authority to those with whom the aa. Trade associations.
agent deals? (1) Indicate whether the Company is a
(4) If independent contractors are used, member of any trade association(s).
are they permitted to set prices? Are (2) List all such organizations with
they given a sales quota? Are they which the Company has
truly independent contractors? any contract.
x. Identification of agents. (3) Indicate the relationship between
(1) List the titles and positions of those the Company and such organiza-
who, under a reasonable interpre- tions.
tation of the statutory and case law of (4) Indicate whether any of the organi-
the jurisdiction in which they sell for zations above listed have been inves-
the Company, could be considered tigated by any state or federal group,
agents of the Company. either administrative, judicial, or
(2) Do any such agents act through legislative, for possible anti-trust
contractual relationships? violations during the last five years.
y. Sales forms. (5) If so, explain in detail the outcome
(1) Does the Company have sales forms of the investigation and what
that are considered to be offers impact, if any, this had on the
tendered for acceptance by the Company.
purchaser, or bb. Material transactions with insiders
(2) Does the Company have forms that and affiliates.
are considered offers to the Company (1) Obtain material of any material
when executed by a purchaser? If the transactions within the last five
latter is used, is acceptance accom- fiscal years with any insider (i.e.,
plished at the home office or by the any director, officer or substantial
agent in the field? owner of the Company’s securities)
z. Direct sales. or any associate of, or entity
affiliated with, an insider.
(1) List those jurisdictions in which
direct sales are made by the 4. Regulation and litigation.
Company. a. Various items relating to regulation
(2) List those jurisdictions in which litigation.
direct sales are made through an (1) Obtain all letters sent to the
independent contractor or Company’s independent auditors in
distributor. connection with its audits for the
past five fiscal years, including
“litigation letters.”
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Appendix D: Due Diligence Examination Outline
(2) Obtain copies of letters from the were checked by local governmental
auditors to the Company regarding its authorities for possible violations
internal management controls. of local governmental codes, and
(3) Obtain active litigation files for indicate the results of such
material litigation, including letters investigation.
asserting claims, complaints, (4) If any of the Company’s facilities
answers, etc. are borderline, indicate any
(4) Obtain any settlement documents for remedial steps that should be
material litigation. undertaken at this time.
(5) Obtain any decrees, orders, or (5) List any warnings that the
judgments of courts or governmental Company has received within the
agencies. past three years for the violation of
any local governmental codes.
(6) Obtain information regarding any
material litigation to which the (6) List the date and amounts of fines,
Company is a party or in which it may if any, paid to any local govern-
become involved. mental authority for violation of
local codes, other than the traffic
(7) Obtain audited financial statements
code, paid by the Company during
(five years).
the last three years.
(8) Obtain recent forward-looking
d. Contract defaults.
budgets for the next two fiscal years
prepared on a monthly basis (if (1) Is the Company presently in
available). default under any contractual
arrangement?
(9) Obtain recent five-year projections
(if available). (2) If so, explain the default and
indicate the penalties arising out of
b. Pricing policies.
such default.
(1) Does the Company, in its pricing
e. Liens.
policies, follow an industrial leader?
(1) List all liens presently in force
(2) If so, which competitor does the
against the Company’s property,
Company follow as leader?
both real and personal.
(3) If not, how are the Company’s
(2) Have any actions been taken in
pricing policies determined?
respect to any such liens?
c. Compliance with building codes.
f. Legal action.
(1) Is the Company in compliance with
(1) List all legal actions presently
all building codes (or other similar
pending or known to be
local governmental codes) that are
contemplated in which the
applicable to it?
Company might have an
(2) If not, explain. involvement.
(3) Indicate the approximate date of the
last time the Company’s facilities
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Going Public
(2) Ascertain the identity of legal (2) Does the Company retain any
counsel representing the Company lobbying firms?
in such matters. k. Tax compliance.
g. Assignment of patents, trademarks, (1) Does the Company file all required
and copyrights. tax reports?
(1) Obtain the form used in which (2) If not, explain.
employees assign to the Company
(3) How long are tax records kept?
any patent, trademark, and/or
copyright that might arise from (4) Does the Company have its tax
inventions discovered while records reviewed periodically for
working for the Company, together compliance with tax laws?
with a list of the employees who (5) How often are the tax reports
have signed the contract. If a form reviewed and by whom?
is not used, should it be? (6) Does the Company utilize tax
(2) Does the Company have counsel in the planning phase of
nondisclosure agreements with transactions?
employees? (7) If so, is tax advice rendered by
h. Surety bonds. house counsel or outside counsel?
(1) Indicate those employees (by title (8) How are audits by governmental
or position) who are presently tax authorities conducted?
covered by a fidelity or other l. Year 2000 compliance.
surety bonds.
(1) Assess the affect on the company of
(2) What are the amounts of any its compliance with the Year 2000
such bonds? transition, taking into account the
i. Charitable contributions. costs, potential disruptions of
(1) Indicate the number and amount productivity, potential liabilities
of charitable contributions made related to company products or
by the Company in each of the services, and compliance by
last two years in the following suppliers.
categories: (i) religious, m. Subsidiary information.
(ii) educational, (iii) other. (1) Identify the Company’s
(2) Does the Company have any policy subsidiaries.
regarding employee charitable (2) Where material, provide the
contributions? information above with respect to
j. Lobbying activities/political campaigns each subsidiary of the Company.
(1) Indicate whether the Company is
engaged in any lobbying activities
or political campaigns and, if so,
to what extent, and at what
financial cost.
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Appendix D: Due Diligence Examination Outline
K. Review of Officers’ and Directors’ a. The items of the applicable form
Questionnaire (e.g., Form S-1, Form S-2, Form
S-3, Form S-18) and
1. Obtain from the Company’s counsel
the “officers’ and directors’ question- b. Regulation S-K (to the extent
naire” to gather information on the covered by the applicable form).
Company’s officers and directors, (1) Item 501-Forepart of Registration
their remuneration and employee Statement and Outside Front
benefits, and material transactions Cover Page of Prospectus.
that they have had with the (2) Item 502-Inside Front and
Company. Outside Back Cover Pages of
2. Compare the information disclosed Prospectus.
in the questionnaire with the (3) Item 503-Summary Information,
disclosure required by the applicable Risk Factors, and Ratio of
registration form, especially in regard Earnings to Fixed Charges.
to:
(4) Item 504-Use of Proceeds.
a. Insider transactions and loans.
(5) Item 505-Determination of
b. NASD Regulation affiliations. Offering Price.
c. Litigation. (6) Item 506-Dilution.
d. Cheap stock. (7) Item 507-Selling Security
e. Stock ownership. Holders.
(8) Item 508-Plan of Distribution.
L. Check of Order Backlogs
(9) Item 509-Interests of Named
1. Compare oral purchase orders or
Experts.
oral changes to written purchase
orders. (10) Item 510-Disclosure of
Commission Position on
2. Do cancellation provisions exist in
Indemnification for Securities Act
standard purchase orders, including
Liabilities.
any penalties for cancellation?
(11) Item 511-Other Expenses of
3. Are there indications that
Issuance and Distribution.
outstanding offers may be “soft,” or
subject to cancellation? (12) Item 512-Undertakings.
3. Review the registration statement on a
M. Detailed Review of Draft of line-by-line basis with appropriate
Registration Statement individuals, including:
1. Read the draft of the registration a. Officers of the Company responsible
statement carefully for content. for preparing the registration
2. Read the draft of the registration statement.
statement a second time against:
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Going Public
b. The Company’s counsel. O. Review During Negotiation of Underwriting
c. Representative of the Company’s Agreement
certified public accountants. 1. During negotiations on representations
4. Based on the information elicited and warranties in the underwriting
through discussions with various agreement, be sensitive to potential
individuals, encourage that the problems that arise and may need to be
registration statement be revised in an disclosed in the registration statement.
effort to improve upon 2. Review legal counsel’s summary of the
its disclosure. Company’s minutes.
5. After a revised draft of the registration
statement is available, see that it is III. Summary Analysis
distributed to all directors and key
officials. A. Prior to effectiveness of registration
statement, prepare a memorandum
6. Review the Company’s procedures for
summarizing the due diligence investigation,
collecting and evaluating comments
including the dates of any visits to principal
on the registration statement from
facilities, meetings with management, and
those persons to whom it has been
registration statement review sessions.
furnished.
B. Have this memorandum reviewed by counsel
N. Review of Other Documents
for the underwriters.
1. Review documents not previously
furnished, including those of a
confidential nature that the Company
would prefer not to be taken from its
offices, including:
a. Five-year plans.
b. Financial forecasts.
c. Budgets.
d. Periodic reports by operating units
to senior management or the board
of directors.
e. Letters of comment received by the
Company in connection with prior
registration statements.
f. At least the most recent
management letter prepared by the
accountants in connection with
their audit.
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