When it comes to selling a business, the there are three major factors that can kill a deal after the letter of intent (LOI) stage, or materially change the terms of the deal. They are:
- Deterioration of business post LOI and before the close
- Negative surprises identified during the due diligence process
- Complexity of terms and extended delays in nailing down the terms
As surprising as it may sound, most of these problems can be reduced significantly by the seller preparing for due diligence beforehand.
For example, let’s take the deterioration of business performance post LOI. This is a risk in many deals, especially if there is a large window of time between the LOI and the close of the deal. Often, the time lag is a function of the time it takes to do due diligence. But what if the seller is prepared for due diligence and can have the required materials readily available? Would that reduce the gap between LOI and close? Would the smaller time window lower the risk of adverse developments? We believe, the answer, more often than not to these questions, is that being prepared for due diligence can work in the seller’s favor.
The same goes with the buyer finding negative surprises during the due diligence period. Would the seller be better off conducting pre-diligence and identifying potential issues before the actual diligence is done? Would that lead to a more favorable outcome during the actual due diligence process? The answer, once again, is affirmative.
And finally, complexity of terms can draw out the time between an LOI and final purchase agreement. Quite often, the complexity can come from addressing the risk factors found in due diligence. Would pre-diligence help identify the issues and have solutions in place? Would that help improve the odds of closure? Once again, the answer is affirmative.
The root cause of all of these problems is the same: Surprises that cause delays. As any dealmaker will affirm, delays are deal killers. Delays take management attention away from the task of running the business, and delays introduce complexities. Delays have mysterious ways of highlighting negatives and resulting in buyer’s remorse prior to the consummation of the transaction.
Four steps for pre-due diligence
To avoid surprises, it is highly beneficial if the seller can take the time to conduct thorough due diligence prior to putting the business on the market for sale. This pre-diligence process would have to be done in four steps.
1. Identifying due diligence areas: Follow a thorough process to do due diligence similar to what a competent buyer would do. There may be a tendency on the part of the teller or the dealmaker to short cut this diligence list, but in actuality, a more thorough approach is preferable to cursory approach.
2. Conducting due diligence: Performing pre-diligence can be a lengthy and testy period for a seller to appreciate. However, it is important to realize that the output from this exercise is not only valuable in identifying any shortcomings, but the output may also form the baseline of the due diligence that gets handed out to potential buyers at a later date. More work up front almost certainly means less work later. It is also important during this process that the results are staged on an internal server and ready for later use.
3. Develop strategy: It surprises some of our clients that the due diligence, in addition to finding problem areas, tends to bring forth some low hanging opportunities that have not been captured by the seller. For any opportunities or negatives that surface in pre-diligence, a concrete action plan should be made to exploit the opportunities or to create positive messaging for the problem areas.
4. Go/No-Go decision: The strategy from step 3 will determine will highlight valuation opportunities and challenges and the seller can decide if he should continue with the current exit strategy.
Areas of Pre-Due Diligence by Industry
In terms of identifying the areas for due diligence, we believe that the following areas need to be covered exhaustively.
Corporate: Corporate Organization, Charter Documents, Minutes, Resolutions and Consents
Corporate Structure & Related Records: Stockholder Records, Buy Sell Agreements, Debt Financing Details.
Government Matters & Corporate Umbrellas: Corporate Umbrellas, DBAs, LLCs, etc., Good Standing & General Compliance, Compliance with State, Local, Workplace & Environmental Laws, All Litigation – Past, Current and Pending.
Financial, Accounting & Tax Information: Financial and Accounting Information, Tax Filings.
Operating Information: Organization Charts & Key Employee Information, Employee Benefits and Pensions, Employee and Management Agreements, Key Customer & Supplier Details, Production and Outsourcing Agreements, Marketing Arrangements.
Asset Quality: Intellectual Property Rights, Procurement, Operating & Maintenance Data, Property Interests, Ownership Data, and Related Agreements, Insurance Agreements.
Markets & Competition: Market Data, Marketing Plan, Competitor Data.
We recommend budgeting a few weeks at the beginning of the business sale process to conduct detailed pre-due diligence, and believe that this will lead to a much smoother exit when the right acquirer appears at the negotiating table.
