It’s estimated that only about 80% of all Letters of Intent ultimately result in a closing, usually because the transaction didn’t survive the due diligence process. At the same time, it’s safe to say that no aspect of the business acquisition /sale process is more mysterious, or more poorly understood by business sellers than due diligence.
So what is involved in due diligence, and how can business sellers be better prepared for it?
It’s important to understand due diligence from the buyer’s perspective and keep in mind that it’s not personal, it’s strictly business. Before investing a comparatively large sum of money, any buyer will seek assurances that they are getting exactly what they expect, and there won’t be any surprises. In a typical, lower middle market, M&A transaction due diligence will have several phases and may take from 1 – 3 months, and possibly longer. The buyer will engage other professionals to assist with due diligence, including, attorneys, accountants, consultants, and service providers.
Business Due Diligence – The buyer will want to verify the sustainability of your revenue and cash flow, as well as understand the potential for future growth. What products & services does your company offer? Who are your competitors? Why do your customers buy from you? Will they continue to buy under new ownership? Are there customer concentration issues? What is your relationship with your vendors? Are there vendor concentration issues?
Accounting Due Diligence – The buyer will want to verify the accuracy of your revenue and cash flow reporting, and it’s consistency with generally accepted accounting principles (GAAP). Sometimes this is referred to as a Quality of Earnings Analysis. Expect the buyer’s accountants to require documentation of any and all add backs, and verify recent tax returns.
Legal Due Diligence – The buyer’s attorneys will review all material contracts and purchase orders with customers and vendors; all leases and employment agreements; city, county and state business licenses and annual report filing; the corporate record book for being complete and up-to-date; any current or pending lawsuits; and perform background checks on key personnel.
IT Due Diligence – Depending somewhat upon the industry, the size of the company, and the importance of Information Technology in its operations, the buyer may engage consultants and/or service providers to assess the soundness of the company’s IT, and identify any vulnerabilities, and any near-term fixes or investments that may be required
Environmental Due Diligence – Depending somewhat on the nature of the business, the buyer and the investors may require an Environmental Phase I Assessment to determine any environmental liabilities.
Insurance Due Diligence – Again depending somewhat on the nature of the business, the buyer may engage a risk management consultant to determine if the company is adequately insured.
Clearly the due diligence process imposes a huge burden on the seller and the management team who are already burdened with running the company, but there is no way around it. The best way to prepare is to: (1) Anticipate all the documents that will be requested, and begin assembling those in advance, (2) Involve all of the right people on your team, and (3) Keep your eye on the prize to achieve the best possible outcome.
If you, or someone you know, may be thinking about buying or selling a business, and who might benefit from a complimentary, confidential, consultation with us, please contact me directly at 813.299.7862, or mertel@lmaallc.com
By: Mike Ertel, Transworld M&A Advisors