SaaS M&A Due Diligence Checklist: Prepare 6 Areas of Your Business for a Successful Exit

The best way to prepare for due diligence in a SaaS M&A transaction is to do most of the legwork before it starts.

SEG has helped software companies successfully go through due diligence for over 30 years. We break down due diligence for SaaS companies into six areas of focus:

1. Business Diligence
2. Accounting Diligence
3. Tax Diligence
4. SaaS Diligence
5. Tech Diligence
6. Legal Diligence

In this checklist, we’ll dive into each area and its importance. We also provide an in-depth downloadable M&A due diligence checklist (PDF) so that you’re set up for success.

1. Business Due Diligence Checklist

Business diligence includes the core tenants of your business model and operations. It’s sometimes referred to as administrative diligence. Here are a few items you should consider.

Priority Requests

The most important checklist items include business information pertaining to operations as well as revenue. This includes historical income statements, an employee census, customer contracts, third-party contractors, sales booking data, detailed revenue tracing, and at-risk customers.

Sales & Marketing

A main function of due diligence for SaaS companies is to get a sense of how well the company’s sales pipeline, sales compensation, and marketing efforts are working. Pricing books, average selling price, and historical sales productivity are all included in this area.

Financials

Examining backlogged revenue, audited financials, balance sheets, cash flow, profit and loss statements, and business expenses are included here. Additionally, details on historical or projected capital expenditures are included.

Customer Support

Be ready to provide a look into customer support incidents, calls, and resolution times.

Development

The final section of business diligence looks at development as it pertains to the product architecture, including lines of code counts by product area, development backlog, development staff allocation by skill set, and product roadmap. Custom solutions in the customer base as well as third party software packages will also need to be shared here.

2. Accounting Due Diligence Checklist

Accounting due diligence involves reporting around all the financial areas of the business in greater detail, including cash flow, customer contracts, income statements, expenses, liabilities, and other related requests. Consider these 11 areas of accounting due diligence.

General

Accounting due diligence includes looking at how the company is performing. This means providing annual financial statements, detailed financial statements, access to historical audit work papers, a description of any significant or unusual accounting controls, and copies of the top five customer and vendor contracts.

Income Statement

When it comes to income statements, the company will need to provide the billing register for the past three years, a breakdown of costs and goods sold, operations expenses by department, cost of services by department, and a narrative description of the company’s policies and procedures relating to revenue recognition, as well as terms of sale.

Cash

During diligence, the seller should provide all documentation related to bank reconciliations, agreements, and indentures related to borrowing money or mortgaging any company assets.

Accounts Receivable

To ensure the company is being paid by customers, a ledger of accounts receivable is examined. This can include a doubtful accounts balance, a receivable aging report, significant receivable balances over 90 days from invoice, bad debt write-offs, and policies and procedures relating to payment terms, credit policies, and reserving accounts receivable.

Contracts, Commitments, and Contingencies

Buyers will examine contracts and financial commitments during due diligence. The documentation provided should include copies of all payment schedules, future commitments, current purchase and sale commitments, and outstanding litigation claims (formal or informal).

Additional Requests

Buyers will want information on credit memos, invoices and deposits, property and equipment valued over $1,000, and management and shareholder expenses. Additionally, all invoices, balance sheet accounts, monthly revenue, and deferred revenue calculation worksheets should be shared.

3. Tax Due Diligence Checklist

Tax due diligence is one of the more straightforward areas of examination during an M&A deal and is typically handled by tax experts. It involves reporting all relevant tax information over the past few years, as well as providing any relevant documentation for federal forms.

Priority Requests

The main requests include all copies of federal, state, local, and foreign income tax returns filed for open tax years, as well as all exceptions, contingencies, liabilities, rulings, and outstanding items as they relate to taxes.

Tax diligence also includes all tax information regarding employment status and compensation, as well as contractors and additional forms filed for employees across the company.

4. SaaS Due Diligence Checklist

SaaS companies have unique areas that need to be disclosed in a due diligence process. This includes relevant information about the software platform, service, security and compliance, and any relevant methodology and processes.

Supplier/Asset Management

Buyers will want an overview of all suppliers and services as they relate to the software, as well as examine with more scrutiny where control lies within those relationships. For example, service-level contracts, contract terms and end dates, change of ownership clauses, and provisioning cycles should be provided. Additionally, buyers will want to know information regarding key assets, outstanding disputes, and hosting/facility management agreements.

SaaS Platform

SaaS companies will be asked to provide details on the make and model of servers the service runs on, memory required, and disk storage required. It is also a good idea to have information on how the service is monitored in real-time, support personnel alerts, printing requirements (if any), and all documentation for operational procedures.

Connectivity

This part of SaaS diligence seeks to understand how users connect to the software or service (e.g. the network architecture, bandwidth, protocols, user percentage of bandwidth, etc.).

Service

How does the service work in the eyes of the customer and from the backend of the business? Provide documentation around customer expectations, scheduled downtime, how services interact, reporting, and vendor software. Sellers should also help the buyer understand the service by providing data flow diagrams, service infrastructure outlines, user interface types, and recovery/restart procedures for application-failure scenarios.

Disaster Recovery

On that note, buyers will want to know the plan in the case of a disaster scenario for the software. Some information to provide: your company’s disaster recovery (DR) offering, recovery-time objectives, customer contract/SLAs related to DR, DR documentation, DR exercises, and backup and recovery mechanisms.

Quality

Quality service-level agreements, quality objectives, and quality measurements are included. Descriptions of the service architecture that handles software, hardware, and power failures (as well as software and hardware upgrades) gives a picture of quality.

Security/Compliance

Security and compliance are increasingly scrutinized areas of diligence. Descriptions of the physical and logical security of the service, as well as detection plans and processes are great to gather before diligence. After all, information about vulnerabilities, protecting data, and the company’s audit history are vital for security.

Application

Think of this section of SaaS diligence as the application deep dive. This includes everything from messaging data flows to application architecture. Application documentation is crucial to helping the buyer understand how it works (backend and frontend), how customers pay for it, how you built it (proprietary software, open source, etc.), how you secure it, and what the future looks like in terms of upgrades, maintenance, and reliability.

Methodology and Processes

In this area of SaaS diligence, you’ll need to provide descriptions of your company methodology as it relates to lifecycles, change management, escalation management, problem management, and new client implementation.

Performance Management & Client Support

Finally, SaaS diligence will require you to share how you measure application/service performance and the standard reports that go along with that, both internally and externally. Similarly, client support hours, escalation procedures, help desk tools, and technology will all be examined.

5. Technology Due Diligence Checklist

Tech due diligence looks very similar to the SaaS due diligence checklist but entails reporting on all information surrounding business application operations rather than the software the company is selling.

The following sections have very similar information as SaaS diligence, except in regard to business applications/internal software, provided:

Network

Buyers will want to know the network architecture of the environment, including bandwidth, protocols, user requirements, and telephone switch technology/tools to support the user base.

Business Application Operations

Sellers will be asked to compile required internal business applications, their expected availability, maintenance windows, supporting infrastructure, user interfaces, and recovery/restart procedures. Additionally, engineering/technical support job descriptions for those supporting the internal tech environment should be provided.

Help Desk Support

Similar to client support, help desk hours, on-call support, and any help desk tools and applications to keep track of incidents should be documented and shared.

6. Legal Due Diligence Checklist

Conducting legal due diligence ensures liabilities, insurance, litigation, and intellectual property matters are considered. Similar to tax diligence, a professional legal team conducts this diligence.

Intellectual Property

All documentation relating to the company’s intellectual property rights (patents, trademarks, copyrights, trade secrets, etc.) need to be compiled and shared. This also includes all employees and contractors who developed the IP, source code used, and any threatened infringement.

Without proof of sufficient IP ownership, diligence is likely to fail. Preparing this (and keeping IP in mind from the start) is crucial to a successful diligence process.

Corporate Matters

Corporate legal diligence entails providing legal information regarding the corporate structure, a certificate of incorporation and bylaws, minutes of meetings, jurisdictions where the company owns real estate, and agreements related to the control and ownership of the company.

Additionally, any profit-interest plans, stock option plans, intercompany services and agreements related to the corporate structure should be provided. In essence, compile anything corporate and legally binding here.

Litigation and Contingencies

Buyers should be in the know about any pending, threatened, or outstanding litigation against the company. This includes descriptions and related legal documents involved in those processes.

Insurance Matters

A summary of the company’s insurance coverage, claims, and worker’s compensation claims that are pending or historical should be provided.

Property

This section is straightforward: Buyers will want the seller to provide documentation on any real estate owned or leased by the company, including agreements, locations, and material personal property.

Regulatory Matters

This includes any government approvals, permits, or filings in regard to a regulatory authority.

Labor and Employee Matters

This section refers to any legal documentation related to company obligations to employees and labor. This includes health, welfare, insurance, bonuses, compensation, NDAs, non-competes, indemnification agreements, and schedule of compensation paid.

Material Contracts

Finally, material contracts related to the borrowing of money or mortgaging should be compiled and documented during legal diligence. This includes any agreements or guarantees of obligations, especially in contracts with outside groups, partners, or suppliers.

Download SEG’s free M&A Due Diligence Checklist.

As you can see, preparing for diligence is arduous and intensive. But we can help. At SEG, we have the expertise to successfully execute diligence and keep your deal moving forward. Learn more about our services.