In many cases, business owners tend to view their enterprise through only one lens – their own. They know everything there is to know about their business, the nuances, the shortcuts and secrets. However, when a buyer comes along, it is a different story. Experienced buyers are well-versed in the intricacies of the due diligence process and know exactly what they are looking for and how best to find it. They ask questions that have probably never been asked previously and dig deep, often uncomfortably so.
Unfortunately, most vendors have zero M&A experience, which puts them at a distinct disadvantage. They scramble to effectively respond as the questions flood in, and few prepare effectively. It is this lack of preparation that is often to blame for the failure of a transaction or the renegotiation of key terms to the disadvantage of the vendor.
Before looking at how best to prepare for due diligence, it’s essential first to consider its purpose. A business is a complex asset, with many unique moving parts. Buyers need to ensure they are taking on no more than an acceptable level of risk. The primary purpose of due diligence is to validate underlying assumptions based on the information provided in the early stages. Essentially, a buyer makes an offer on the business based on these assumptions. The purpose of due diligence is to validate those assumptions so that the purchaser is satisfied that transaction terms are appropriate.
However, due diligence also has a dark side. Buyers often expect to renegotiate terms as a matter of course. Once a vendor has signed a Heads of Agreement and undergone the rigours of due diligence, the emotional, financial and time investment makes it more difficult to contemplate walking away when the inevitable post-DD negotiations commence.
Therefore, it’s crucial that any would-be vendors take due diligence preparations seriously and pre-empt as many potential issues as possible. A dry run courtesy of a trusted advisor will put a business under the microscope in a far more congenial environment than a real-life scenario, where every error, omission or surprise is potentially money out of the vendor’s pocket.
Here are some ideas to help vendors prepare:
- Be objective. Look at your business from a buyer’s perspective and be prepared to pick yourself up on any apparent shortcomings. Disciplined buyers won’t entertain excuses, and they don’t like surprises.
- Centralize your information. Having all documentation and information available in one central repository makes the due diligence process smoother. You can manually make copies and create physical files or upload scans and electronic files into a Virtual Data Room.
- Document everything. Business systems, processes, procedures, position descriptions, rationale for any claimed add-backs, any intercompany arrangements, and/or shareholder loans should all be clearly and thoroughly documented for the avoidance of any doubt and future dispute.
- Check for signatures. Every single contract – client, supplier, and employee – needs to be signed by both parties and should be current. Outdated or unauthorised contracts are essentially worthless when it comes to due diligence.
- Ensure proof of ownership. If you don’t own it, you can’t sell it. Check trading/business names, domain names, software licenses, equipment leases, and other assets to ensure that they are owned by a person or company that will be party to the sale of business contract.
These are just some suggestions to pre-empt some of the more common due diligence failures. Forewarned is forearmed, so take action early to ensure that you are not starting behind the eight-ball and leaving yourself open to renegotiations, which will not be in your favor.
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