Be Ready for Due-Diligence!

One of the great “mysteries” in transferring a business is the due-diligence process. Whereas business owners often have a fairly clear concept of a buyer interview and the transfer process, it’s the due-diligence process that makes many of them cringe.

“Business owners are somewhat concerned about due-diligence and providing the most confidential documents to a buyer,” says Achim Neumann, President of A Neumann & Associates, a New Jersey based mergers & acquisitions and business brokerage firm.  “However, the better the upfront preparation or pre  due-diligence, the smoother the ultimate due-diligence by the investor.”

Probably the most important factor is the proper preparation. This includes the assembly of all financial information, the tabulation of operational information, a recap of the market growth/size and competitors and the itemization of human resources. A competent, experienced M&A advisor is absolutely key in helping the owner to compile the information and presenting the business by way of a confidential memorandum in a comprehensive, convincing way to investors.

The underlying preparation needed for compiling the business information will serve to show the business owner and M&A advisor that information is easily obtained and which information is deficient. This is very important with respect to the subsequent due-diligence by an investor once an offer has been submitted. For example, if the business has a poorly operating financial reporting system, MIS improvements need to be made prior to marketing in order to be able to provide up-to-the-minute financial information to a buyer in the due-diligence phase.

Further, every business needs a business valuation from an accredited, third party valuation firm. Without such valuation, buyers will simply discard the asking price and will initiate a “bottom fishing” expedition, wasting a lot of time of the seller and his advisors. A clearly defined and justified asking price will not only avoid such low offers, it will also facilitate an efficient transaction when a buyer contacts his lending source to raise funds – with the lender requiring a quantitative analysis of the business.

With the business valuation and confidential memorandum (sometimes called ‘prospectus’) in place, the business owner has established a base line for an offer by an investor, which will then lead to an offer and the due-diligence process.

Why is the proper preparation and documentation so important? There are significant reasons for such.

First, with a professionally prepared business, the owner himself will feel competent and assured going into any negotiations with a buyer. With a comprehensive confidential memorandum supported by an accredited valuation, the owner can take a firm stand, being proud on his business – as opposed to the owner, who has to spend hours pulling various documents after an investor introduction, with an investor increasingly losing interest in the business. A well-prepared business owner can calmly conduct an investor due-diligence.

Secondly, with a proper documented business, a baseline for an offer has been established, in other words, a buyer can base their offer on the basis of certain underlying presentations. For example, if the confidential memorandum states that a net working capital of $500,000 will be transferred – consisting of $200k in A/R, $700k inventory and $400k in A/P – then a buyer can make an offer knowing that such financials are included in a purchase of the business (subject to adjustment at closing).  Provisioning of just tax returns, in substitution of a confidential memorandum, will leave a wide range of interpretations of what is included and will increase the post-closing litigation risk significantly.

Thirdly, one of the most under-valued outcomes of poor preparation is the fact that a buyer has to wait for the delivery of due-diligence documents that were requested. Such wait has a twofold negative impact: first, the buyer will perceive the business to be inefficient and poorly managed, and secondly, the lack of good due-diligence document flow will increasingly created the perception in the buyer that the seller is not truly motivated to sell the business. Both buyer “conclusions” will most certainly end in the buyer terminating an offer the longer the time stretches out.

Finally, selling a business takes a team effort, in particular, in the due-diligence phase. CPAs needs to review the tax implications of the offer for both parties, and attorneys need to draw up the Definitive Agreement. A poorly prepared business without a comprehensive confidential memorandum will result in a business owner very anxiously trying to coordinate advisors – with a high probability for errors – and consistently trailing document requests.

In sum, whereas a business seller might fear the upcoming due-diligence, in reality, however, it’s merely a verification of a previously – presented business description.  A business seller who is well prepared will not have to be concerned about any “smoking guns” in the due-diligence process, and byvirtue of such preparation, he can ensure a smooth process, and thus, significantly increasing the chances that a buyer will indeed complete the full transaction. Be ready for due-diligence!

A highly qualified M&A advisory firm like ours, with hundreds of transactions performed in the past fifteen years, is well versed to guide any business owner through the preparatory and due-diligence process.

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This blog contains excerpts out of the recently published book

The Road Beyond – What Nobody Tells You About Selling a Midsized Business?