Due diligence friend of foe

In Depth Due Diligence….Friend or Foe?

A strong Due Diligence process is the best insurance when selling a company.

Due diligence is very important in the M&A process, although most sellers would just as soon skip this stressful stage they would be making a big mistake. Buyer due diligence is only getting more diligent and, on the positive side, for those buying a company or selling a company it should reduce the possibility of disputes after closing a transaction.

Preparing for due diligence is an important part of a good Exit Plan for a business owner. A seller can increase the business value by establishing business practices, long before a sale is considered, that allow for easy and efficient buyer due diligence. A business that can sail through due diligence will sell get a higher business valuation from a buyer than a business with risks that can’t be identified and quantified during the buyer’s due diligence.

What’s the due diligence practice that can most increase the business value?

Audited or reviewed financial statements performed by a respected CPA firm.

In the wake of the recent economic downturn and scarcity of deal financing, business buyers and their lenders are focused on risk like never before. And they’re using due diligence to head off negative surprises that could surface after closing if their due diligence is inadequate.

Too often business sellers think that due diligence is an exercise in “gotcha” or a fishing expedition to try to manufacture a reason to renegotiate a price. That is not what good buyers want. Good buyers realize that deals that have difficulty getting through due diligence have a very low chance of closing and good buyers want to work on deals that DO close, not spend their time on deals that don’t close.

What are buyers looking for in due diligence?

  • Confirming that what they were told is true
  • Looking for answers to questions the seller couldn’t answer
  • Looking for issues that the seller and buyer hadn’t discussed

Ready for Inspection

Most of the information that a buyer wants during due diligence is information that a well run company already collects on a monthly basis. For financial due diligence things like:

  • Accurate monthly financial statements including P&Ls, balance sheets and cash flow statements
  • Backlog or work in progress reports
  • Tax payments and liabilities
  • Inventory cost system and inventory obsolescence reports
  • Accounting for warranty costs
  • Booking employees financial obligations. Earned time-off/vacation.

For operational due diligence:

  • HR policies and practices. Are your employees categorized properly? Exempt, non-exempt, 1099 contractors. Are your policies and practices non-discriminatory
  • Litigation: current, past, potential
  • Customer contractors
  • Vendor agreements
  • Leases
  • Environmental compliance
  • Licensing requirements
  • OSHA practices

Most will agree that doing the above correctly and consistently is good business practice and will enhance the business value while you own it as well as when you’re ready to sell.

As with all facets of the due diligence process, it’s essential that you provide accurate and full disclosures of all aspects of your business. Most business owners choose to sell their business because they want to be free from the worries and risks of business ownership. If you prepare your business for sale you’ll get a better deal with easier due diligence and less risk that the sale of your business might cause more problems than it solves.

Regardless of your time frame for your exit strategy now is the time to start running the business so that you are enhancing its value.

Although due diligence by buyers is more comprehensive than ever, there is a silver lining. The more due diligence a buyer does the lower the seller’s risk that the buyer will have a claim after the buyer has purchased the business.