Navigating the Due Diligence Period: Don’t Let the Deal Die!!
- glenn13205
- Jul 19, 2024
- 5 min read
Updated: Jul 19, 2024
Yay, we have a deal!!!
The signing the Heads of Agreement (HOA) marks a significant milestone in the business acquisition process, however, once the euphoria has died down, reaslisation sets in that there’s still work to do to execute the deal.
Welcome to the Due Diligence (DD) phase of the transaction, where many deals fall over unless managed correctly.
This phase is pivotal for both buyers and sellers and involves a thorough examination of the business to confirm the details presented by the buyers is correct and to uncover any potential issues that could affect the transaction.
Sellers often find the Due Diligence (DD) period challenging and intrusive. It requires a deep dive into every aspect of their business, looks at sensitive and confidential information and involves extensive scrutiny of financial records, legal documents, operational processes, and commercial data. It can also be overwhelming and time-consuming.
Additionally, the need to continually request detailed information and clarifications can put a strain on the relationship with the owners who might perceive it as distrustful or overly invasive.
I relate to the fact that “no one likes being told their baby is ugly”.
Managing this process is a delicate balance and, in this post, I outline some simple steps to ensure that both parties can maintain a balanced view. Again, open communication is key, as this will continue to build trust and rapport, and ensure that the transaction is executed equitably
The Due Diligence Process
There are four key steps to an effective due diligence process, which are:
1. Planning and Preparation
For sellers, the due diligence process is a pivotal stage that requires thorough planning and preparation to facilitate a smooth transaction and instill confidence in potential buyers.
Effective due diligence begins with setting a clear timeline, typically ranging from 30 to 90 days depending on the complexity of the business, to ensure the process stays on track.
Sellers should have their own team of legal and financial experts to assist in presenting accurate and comprehensive information to buyers (see my previous post on how to minimise costs here).
Creating a detailed checklist of required information is crucial, including financial documents such as income statements, balance sheets, and tax returns; operational details like supplier contracts and inventory lists; legal documents covering contracts and intellectual property rights; and commercial information, including market analysis and competitive landscape.
By scheduling regular updates through periodic meetings, sellers can keep the process organised, address any issues promptly, and demonstrate their commitment to transparency and cooperation.
This meticulous preparation helps to build trust with buyers and increase the likelihood of a successful transaction.
2. Gather information and Undertake Due Diligence
As a seller, it's crucial to recognise that buyers will want to collect comprehensive information to understand the full scope of your business operations. The four main areas they will explore are:
Operational Due Diligence: Buyers will assess the day-to-day operations, focusing on supplier contracts, customer relationships, and operational processes. They will want to ensure that the business runs smoothly and efficiently, identifying any potential issues that could impact future performance.
Legal Due Diligence: Buyers will examine all legal documents, such as contracts, intellectual property rights, and pending litigation. Their focus will be on uncovering any legal risks or liabilities that could affect the business post-acquisition, ensuring all legal matters are in order.
Commercial Due Diligence: Buyers will analyze the market position, competitive landscape, and potential growth opportunities. They will focus on understanding how the business stands in its industry, its market share, and the viability of its long-term strategic plans.
Buyers will thoroughly verify and analyse each of these areas to ensure the accuracy and reliability of the data collected. Additionally, they will look to identify potential risks and liabilities, such as regulatory compliance issues or financial discrepancies.
It is important for sellers to be open and responsive throughout this phase. Remember, this scrutiny is not personal; it is a necessary part of any business purchase. Buyers are risking their capital and want to ensure that their offer is based on sound underlying fundamentals. By cooperating and providing transparent information, sellers can facilitate a smoother due diligence process and build trust with potential buyers.
3. Valuation and Adjustments
As mentioned above, buyers will conduct a detailed review of earnings, assets, liabilities, and market conditions to validate the financial health and future potential of the business. Various factors from this analysis can influence the valuation, potentially leading to changes in the purchase price, alteration of the payment terms, or inclusion of additional warranties and indemnities.
For sellers, it is essential to be aware that the offer might change because of the due diligence process.
For instance, if the business's EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortisation) has been overstated, the buyer might reassess the value of the business. Other factors that could influence the valuation include discrepancies in financial statements, unexpected liabilities, or the identification of any legal issues or statutory noncompliance.
This doesn’t mean Sellers should just accept a new valuation or adjustment to the terms. There are often valid reasons for the differences. Sellers just need to be prepared to explain any identified variations discovered during the due diligence process and provide reasons why the initial offer should be maintained.
By acknowledging the possibility of valuation adjustments and being ready to address any concerns the buyer might have, sellers can ensure that only necessary adjustments are required.
4. Finalising the Deal
Once the due diligence process is complete and the existing or new deal terms have been agreed upon, the next step is the finalising the deal.
This stage involves drafting and executing the Sale and Purchase Agreement (S&P), which formalises the terms of the transaction. Both parties will work closely with their legal and financial advisors to ensure that all aspects of the agreement accurately reflect the negotiated terms and any adjustments made during due diligence.
This includes detailing the payment structure, any contingencies, representations and warranties, and the responsibilities of each party post-transaction.
Advice for Sellers
✔️ Be Prepared and Organised: Assemble all necessary documents and information beforehand. A well-organized presentation can speed up the DD process and leave a positive impression on the buyer.
✔️ Address Potential Issues Upfront: Disclose any known issues early to avoid surprises. This honesty can prevent future disputes and demonstrate integrity.
✔️ Stay Involved: Engage actively in the DD process. Respond promptly to requests for information and be available for discussions.
Conclusion
The Due Diligence period is a critical juncture in the acquisition process, requiring meticulous attention to detail from both buyers and sellers. For sellers, it’s a chance to demonstrate the value and stability of their business. By approaching this phase with thorough preparation, clear communication, and a collaborative mindset, both parties can pave the way for a successful transaction.
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