Most middle-market business owners will sell one company in their lifetimes, so it’s understandable if they find the process of due diligence perplexing. After all, their expertise resides in the business they have built over time, not the intricacies of selling a company.
If you’re preparing to sell your business, it’s vital that you don’t underestimate the importance of due diligence. Take time to learn more about the process and what information potential buyers will expect you to produce prior to agreeing to a deal. An experienced M&A firm that understands your industry niche can act as your guide.
So, what IS due diligence anyway?
In simple terms, due diligence is a verification and documentation / information gathering process (also known as discovery), whereby a buyer validates their decision to buy a company and prepares for closing. Due diligence is vital, because it helps the buyer verify financials, review the quality of earnings and ensure the company’s past and potential opportunity for growth aligns with what the buyer believed it to be at the letter of intent (LOI) stage. Middle-market CEOs can typically expect this process to last about three weeks, unless the business operation is highly complex.
Depending upon the type of business, the acquirer may request information, documentation and interviews pertaining to a variety of concerns during the discovery process. These items may include, among other things: management bios; financial statements and records; existing contracts; customer base and diversity information; sales forecasts; lease agreements; marketing and sales materials; operations processes and programs; legal documents; and, security, technical and I.T. systems.
Tip: For a deeper dive into the information and documentation that acquirers will request, read this earlier post:
The buyer is looking for any information pertaining to possible liabilities that they could potentially assume upon purchase. Such liabilities can alter the valuation placed on the company and will have to be dealt with at closing.
In addition to liabilities, buyers will analyze opportunities for future revenue to ensure the value they have placed on the company’s potential earnings is accurate. Some acquirers (especially strategic buyers) will also gather insight to help ensure that the company’s operations, people and processes would provide a good culture fit for their organization.
Tip: Want to learn more about the importance of a symbiotic culture fit and helpful tips you can utilize to blend cultures? Read this two-part blog post series:
Why is due diligence important when selling a company?
The due diligence process is important to sellers, because it equips them with the information necessary to determine a realistic valuation for their business, and potentially avoid leaving money on the table. Sellers should perform their own internal due diligence process prior to opening their books to buyers. It’s especially important at this time to uncover and fix any unresolved legal, tax or regulatory issues that could complicate, delay or sink a potential sale.
If there are any outstanding concerns, the seller should consult with their investment banker regarding when and how to present these issues to the buyer. Sellers should be upfront with buyers early on and avoid hiding problems, because surprising a buyer during the due diligence process is never a good idea.
Six pieces of due diligence advice for sellers
Due diligence can be an intense process, so sellers should keep the following considerations in mind. First, be thick skinned. If you’re like many sellers, you probably built your business from scratch. Understandably, it may be difficult to watch people scrutinizing your past business decisions. Don’t take this scrutiny personally. If the shoe were on the other foot, you would likely approach the process with the same inquisitiveness.
Second, it is in your best interest that the due diligence process doesn’t drag on, so you can get to the closing table quickly. Be organized from the get-go, and do your best to respond to questions and information requests in a timely manner.
Third, continue running your business as you normally would. If you don’t, you might risk a sudden dip in sales or get behind on paying suppliers, which could complicate or compromise the closing.
Fourth, confidentiality is critical at this stage in the game (you don’t want to alert employees or customers that a deal is in the works), so sellers should only share their plans with employees on a need-to-know basis. You should also be prepared to respond to inquiries should there be an inadvertent leak of the sale.
Fifth, assign one person to represent your company during the due diligence phase. Most business owners find that assigning one point of contact to manage due diligence requests can simplify the process and maintain order.
Finally, rely on your investment banker for due diligence and M&A guidance. The due diligence process is complicated, especially if you don’t have experience selling a company. You can save yourself time, headaches and a weak valuation if you engage an investment banker who has experience overseeing due diligence with companies like yours. Top M&A firms understand the pitfalls of the process, have access to a wide range of experts (tax, legal, accounting, personnel, etc.) and know how to prepare sellers for the due diligence and M&A process.