The due diligence process begins from the moment a buyer senses a possible acquisition opportunity. The buyer then starts to examine the information that is readily available at this early time about the company. For public companies, this information is usually derived from public documents—including press reports, filings with securities regulators, and any debt or equity offering memorandums the company or its bankers might have prepared for potential buyers.

This initial stage of due diligence review based on public documents usually starts during the strategy, valuation, financing, and structuring phases, described in the previous chapters. During these phases, the acquirer has asked and answered four opening questions:

• Is it in our stockholders’ long-term interests to own and operate this company?
• How much is it worth?
• Can we afford it?
• How should we structure this acquisition?

When the parties are ready to go forward and to set a tentative price and structure for the deal, the buyer should engage attorneys and accountants to conduct a more thorough study of the company to be acquired. This “dirty linen” phase of the due diligence inquiry—discovering what’s wrong with the company—can never start too early. Buyers often neglect this phase, because they do not want to offend sellers, but they must proceed. Buyers need to ask and answer the tougher questions such as:

• Do the firm’s financial statements reveal any signs of insolvency or fraud?
• Do the firm’s operations show any signs of weak internal controls?
• Does the firm run the risk of any major postmerger litigation by the government or others?

Two milestones marking the official onset of due diligence are the signing of a confidentiality agreement and a letter of intent to buy the company. Formal due diligence usually does not begin until these two documents are signed. More details are specified in the acquisition agreement.