Due Diligence: A Vital Exercise for Buyers & Sellers
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April 10, 2024Due Diligence: A Vital Exercise for Buyers & Sellers
If you are an owner of a privately held lower middle-market business, you may have no idea about the level of detail an acquirer will request during the due diligence phase of a M&A transaction. And, why would you? This may very well be the first (and possibly only) time you will be involved in a M&A transaction.
If you’re preparing to buy a business, there is always a level of risk and uncertainty involved with every deal. An optimum way to mitigate this risk is to educate yourself about the target company you’re considering and acquire a full understanding of its current situation. This is immensely important because, once a transaction is completed, any issues that the selling company has been experiencing are now the buyer’s responsibility.
Ready, Set, Go!
So, once a letter of intent is signed by both parties, get ready, because that’s typically when the due diligence process officially begins! But, of course, this process is different for buyers and sellers:
Buyers – As part of the due diligence phase, the buyer will analyze many things including the seller’s financials, contracts, customers, liabilities, compliance, corporate records, and anything else that is pertinent to the deal and its valuation. Three of the main intentions of going through the due diligence process is 1) to determine the overall viability of a transaction, 2) to fully inform the buyer regarding the seller’s operations, and 3) to allow the buyer to feel confident in moving forward and closing the deal.
Sellers – For those transactions being managed professionally by an Investment Banker or M&A advisory firm, the due diligence preparation begins at the time these firms are engaged. Ideally, this will happen many months before a potential sale. When a buyer is ultimately found, and the LOI is signed the seller will be prepared for the significant amount of data requested.
M&A Firms – Because of their extensive experience in mergers and acquisitions, M&A firms like Touchstone Advisors are very familiar with the checklist of documents typically requested by buyers. It is not unusual for 75-80% or more of the documents that buyers will request to have already been gathered by the M&A firm up front. This delivers a huge advantage because it shortens the time between the signing of the LOI and the closing date
Avoiding the Drama
So why is shrinking the time between the LOI and the closing so important? There is an adage in the M&A business: “Only bad things happen between LOI and closing”. While that’s not always the case, I’ve experienced my share of cautionary tales that have proved the truth of this adage
As a seller, you have struck a deal with a buyer for your business as presented at the time the LOI is signed. But a business is a dynamic enterprise that can undergo changes. What happens if, after the LOI, you lose a major customer, or a key employee? What if a lawsuit is filed against you? There are an awful lot of “what ifs” that don’t involve great scenarios or happy endings. The key to avoiding such selling drama is to shorten the time between LOI and closing – and that can only be achieved if you are fully prepared, in advance, for due diligence.
What’s the Sell-Side Investment in Time?
Your business has its own culture, organizational style and resources. So the amount of time required to complete the due diligence phase for each unique business is dependent on several variables. Among them are: 1) the complexity of the seller’s business, 2) the availability of a resource dedicated to this task, 3) the seller’s motivation to swiftly compile this information and, most importantly, 4) whether the seller has the property prepared for the due diligence process.
The Due Diligence Checklist
Every acquirer is different and each one will have its own procedure for implementing this information-gathering process. Larger organizations will typically have a rather sizeable team of professionals performing the due diligence for them. I have been involved with transactions that brought together several separate companies, each performing a specific category of due diligence – legal, financial, environmental, HR, technology, insurance and more. The list below includes just a few of the categories included in an acquirer’s due diligence effort.
- Organization Legal Documents
- Sales, Customers, and Revenue Streams
- Material Contracts
- Internal and Formal Financial Statements and Tax Returns
- Tax Information
- Insurance Coverage
- Real Estate and Other Physical Assets
- Antitrust and Regulatory Issues
- Litigations
- Information Technology
- Outsourced Contracts
- Employees and Benefits
- Intellectual Property
- Licenses and Permits
- Publicity: Articles, Press Releases, and Media Coverage
Checking Into a Virtual Data Room
So how does a buyer have access to the information being compiled for due diligence? Investment Bankers and M&A firms will utilize a Virtual Data Room (VDR), a secure online repository of documents to which buyers and their teams of advisors can gain admittance. The seller will work with the M&A advisor to upload and store documents in a highly organized fashion. At Touchstone, our dedicated due diligence coordinators facilitate this process for our clients.
Resources, Knowledge, Experience
Due diligence is that critical process that facilitates information sharing to help buyers make informed decisions in M&A deals. This allows the buyer to clearly assess the seller’s business, including both its challenges and opportunities. As a seller, it is crucial to prepare for this phase of the process. Please feel free to contact me to discuss the many ways in which Touchstone Advisors guides our clients through this vital phase. We bring the resources, knowledge and necessary experience to successfully manage the due diligence process on every transaction.
