Preparation is vital for many things but when it can affect the value of your business, it is even more important.
Due Diligence (DD) is the buyers’ way of investigating the business, validating the price (and finding ways to discount it!) and ensuring all potential liabilities are covered in the Sale and Purchase Agreement (SPA).
When planning an exit strategy, it is easy to think the DD process is weeks, if not months away, and there is plenty of time to prepare. However, the amount of time needed to prepare for DD should not be underestimated, neither should the importance of it and the impact it can have on price.
Also, running a DD process can be very time consuming. Numerous financial and legal diligence advisers will be crawling all over the business which can disrupt the day to day operations, distract management and inadvertently impact price – after all, an ongoing profitable business is a more valuable business and maintaining your forecast profit levels during a sales process is critical. The amount of people on site can also risk a confidentiality breach.
Here are our top tips on preparing and managing the DD process to reduce the risk to sellers:
1. Start preparing early
It is important to prepare for DD early, even before a business is taken to market. Early preparation can help identify financial items which can change the way the business is presented to the market and ultimately determine price. It can also identify issues which may affect the timing of any sale or identify other exit options.
It’s not just the financial position. As mentioned in one of our earlier articles, one of the first areas to review is the strength of the management team. It will allow exiting shareholders to evaluate whether a management buy-out (MBO) could be a viable option. It is also important if private equity investors are involved, as they will need a strong ongoing management team.
Legal due diligence (including contractual, property and employment) can also uncover issues which buyers can use to discount the price and/or add warranties and indemnities in the SPA. It’s always best to resolve any legal issues before the sales process or flag them up front to ensure all parties know how they are going to be dealt with.
At JDC we are proactive rather than reactive when it comes to DD. We work hand-in-hand with our clients to identify and deal with issues up front to ensure there are no surprises during the sale process. This means it’s then very rare for a deal to fall over during diligence.
2. Fully stocked data room
Sellers are often surprised by the level of detail requested by both legal and financial advisers during DD and the amount of time it takes to gather detailed financial information, marketing materials, customer and supplier contracts, property documents, tax computations, HR documents and other legal documentation.
Time spent up front preparing and digging out that 20 year old lease tucked away at the back of the drawer can make the DD process less frantic. Find a standard list of DD requirements to aid the information gathering and get started as soon as possible.
Uploading files to an electronic data room will help reduce the amount of time diligence advisers are physically in the business. A data room can also be used to delay the sharing of certain more sensitive information until further down the line.
3. Structured Q&A process
The time spent answering questions during due diligence can become a full time job for some members of the management team. Having one point of contact in the business for diligence can help reduce the impact on the day to day operations, along with a well-managed Q&A process between all parties.
Ultimately, due diligence is full of risks that can materially impact on value and can even cause a sale process to fall over. However, if well managed and well prepared, the process should build confidence with buyers and strengthen your negotiating position around final deal value.
At JDC Corporate Finance, we invest heavily in the DD process and work hand-in-hand with our clients to ensure our deals have the greatest chance of success.