“You will find out things about your business that even you didn’t know.”
And so it was that due diligence expectations were set for the CEO of a mid-sized consulting firm during a recent transaction. The buyer, with the experience of dozens of prior transactions, was well-versed in the vagaries and nuances of the due diligence process and knew exactly what they were looking for and how best to find it. The vendor, with zero M&A experience, was immediately at a distinct disadvantage, and concurred with the buyer’s opening statement once the process was complete.
Due diligence has been likened to having ones teeth pulled without anaesthetic, such is the seemingly invasive and often painful nature of the investigations, particularly for those insufficiently prepared. And 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 we look at how best to prepare, we should first consider the purpose of due diligence. A business is a complex asset, with an often vast number of unique moving parts, so buyers need to ensure they are taking on no more than an acceptable level of risk. Essentially, a buyer makes an offer on the business based on a set of underlying assumptions, which are based on the information provided in the early stages. The primary purpose of due diligence is to validate those assumptions, in which case the purchaser is satisfied that the transaction terms are appropriate.
Due diligence also has a dark side, however, with buyers often expecting 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.
In any event, would-be vendors need to take due diligence preparations seriously and pre-empt as many of the 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. But for those preferring a more hands-on preparation, consider the following 7 ideas:
1. 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, so it’s a great exercise to jump into their shoes for this purpose.
2. Centralise your information. Having all documentation and information available in one central repository makes the due diligence process all the smoother. You can manually make copies and create physical files or upload scans and electronic files into a Virtual Data Room (which can even be on a secure drive on the company’s server).
3. 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.
4. 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, particularly if they are to be novated to new ownership.
5. 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.