Once you’ve agreed to price and terms on a transaction with a potential acquirer or investor, the next step is typically the arduous process known as due diligence. Hopefully you engaged in pre-sale due diligence to make this step go much smoother.
Due diligence is the confirmatory period where the party investing or acquiring your business seeks to understand every nook and cranny of the company. This entails pouring over financial statements (annuals and monthlies) to understand revenue and profitability trends as well as deeper details like cash flow, inventory turn and normalized working capital requirements. Due diligence also happens to be where most transactions fall apart. Buyers will also want copies of all contracts relating to the business including leases, employee agreements, software licenses, bonus plans, health coverage, royalty agreements, distribution agreements, supplier agreements and more.
On top of the items listed above, a savvy buyer will want to see financial projections, defined growth opportunities and may even want to visit with members of the senior management team, major suppliers and key customers. While business owners in smaller, niche or local markets like Connecticut or Pennsylvania are often very protective of critical business information, once diligence starts, the business owner may need to comply in order to secure or defend the agreed upon value of the business. (Managing due diligence requires balancing the needs of the buyer with your need to protect your business. Consult with your advisors before granting buyers access to sensitive information including customers, suppliers and management.)
This may seem like a lot, but put yourself in the buyer’s shoes.
M&A is not like the stock market. What buyers are purchasing is non-liquid and they need to understand the business as clearly as possible so that they can mitigate risk and hopefully ensure their return is up to the standards of their investors or limited partners. The result of this intense period of business scrutiny is that issues are often discovered that can limit value or, worse, derail the entire transaction.
The benefit of hiring a business broker or investment banker to help you through the sale or capital raising process is that you can discover these issues early on by doing an extensive amount of pre-diligence. Properly executed pre-diligence can lead to faster close times and reduced cost of post LOI due diligence.
Prior to marketing your business to potential investors or acquirers your business broker or investment banker will essentially take you through the complete due diligence process as they learn about all aspects of your company through developing the Confidential Information Memorandum (CIM). This may seem tedious and gathering all of the data will take time, but catching any potential issues early on and strategizing with your investment banker or business broker on the best way to diffuse them will be invaluable later on.
Disclosing any issues and avoiding value-lessening surprises is a huge credibility booster in the eyes of buyer and investors, which is paramount to maximizing value.
Legal diligence is also something that should be handled on the front end of the transactions process. Ensuring that all contracts that need to be transferable or assignable are indeed transferable or assignable and that any litigation clouding the company is resolved can save a deal.
Environmental diligence can also be important, especially for businesses that involve chemicals, speciality materials or fossil fuels. Making sure the facility and process are all up to regulation is important. A major environmental issue that affects the business or the real estate can certainly be a deal killer.
Employment issues can be tricky to head off early on, because in most cases you do not want your employees to know the company will possibly be sold. However, making sure all employee agreements are solid and ensuring there are no potential grievances will only make your transaction go smoother.
Pre-diligence, the process of preparing yourself for due diligence, will help mitigate the risk of deal failure and will better prepare you and your company for the involved process that closely follows accepting an offer.