Nothing in this world should be feared – only understood. This particularly applies to a Buyer’s Due Diligence.
Selling the business is meant to be the pinnacle of an entrepreneur’s journey – but often the face of the seller at the end of a process can be one of shell-shock and exhaustion. The term “deal fatigue” is commonly used when the excitement of a deal is sapped out and replaced with frustration and despair at the relentlessness of the diligence process and the countless faceless advisors who delight in bombarding the seller with a blizzard of questions ranging from the most inconsequential to the bizarre. There is no question that diligence can be a miserable experience, but usually that results largely from being ill prepared or failing to appreciating its objective. When selling your home, it is well understood that the buyer will want to have the property surveyed by an expert who will both look for signs of dilapidation or concerns and provide a valuation that can be used to support the required funding. It is readily accepted by the seller that this is a necessary part of the process. At its most basic, diligence to your business seeks to fulfil much the same objectives. It seeks to understand the business, its past, present and expected future, seeking to identify any risks that may exist, in support of the business valuation for both to the buyer’s board and sometimes also to the financing banks. Perhaps the difference with the above analogy is not with its objective but the difference in the breadth of scope of its remit. Companies unlike houses are fundamentally complex beasts. From the moment they are incorporated they wade through multitude of commercial, contractual, fiscal and legal obligations and exposures, and have to deal with the most emotional of creatures - employees. In this increasingly litigious world, it is perhaps understandable that a buyer will want to assess the risks which he will be taking on, particularly since he will be likely viewed as being a target with deeper pockets than the seller for any existing or future aggrieved party.
Consider the buyer's motives - it's not always about price
Instead we should consider the motives of the buyer’s M&A Executive who will have already sold the merits of the business to his board when preparing the offer for your company. He will have based his investment case on the information which you will have shared either through meetings or an Information Memorandum. The point to understand is that any offer will likely be subject to confirmatory diligence which effectively seeks to road-test the claims and substance within the IM. The M&A Executive having already agreed the basis of the deal, engages diligence advisors not to deliberately pick holes in your equity story or find hidden flaws in which to negotiate a price chip, but merely to corroborate that the business marries up to what was previously presented. It is perhaps a misunderstanding about the causal relationship between diligence and price-chips that causes the most fear in sellers. Having negotiated using the IM an attractive price, seller naturally resent having to answer what they perceive as layers of questions each seemingly carefully designed to find flaws or defects in order to reduce the agreed price. This is particularly so when the sellers perceive these to be minor and manageable risks. While problematic diligence issues can indeed sometimes lead to purchase price reductions, most credible buyers are generally more pragmatic and see such issues as problems to be resolved together, and can often come up with minor tweaks to the structure and terms that can overcome their risk, without savaging the deal value itself.
The many faces of "diligence"
Diligence like ice-cream comes in many different varieties. The buyer will often conduct his own operational diligence, which will involve activities such as commercial, operations, quality, human resources and IT. These discussions are usually deemed useful and relevant since it provides the seller an opportunity to explain his business. The Buyer will also engage a range of external advisors to assist in more specialized areas such as legal, financial and tax. If your business is a unique technical capability or within a novel marketplace it may be subject to technical and commercial diligence. If your property is owned, leased or if your processes give rise to waste, a buyer may request respectively – property structure, dilapidation or environmental diligence. This must all sound horrendous to a Seller, particularly when such questions from nondescript external advisors all flood in at once. They are not however in themselves unreasonable questions and in reality, are enquiries which if the table were turned, you as a shrewd entrepreneur would want to know before parting with your own money.
How to approach the questions - getting in the right mindset
Since diligence is a necessary evil to progress an exit, the challenge is how best to approach this mammoth process. Firstly listen to your advisors and be realistic about the resources you will need to support this project and involve sufficient numbers of your senior team, and enlist the help of your accountant, lawyer and perhaps even a project manager to coordinate. This is not the time to scrimp on costs, since a poorly run process will ultimately delay the sale and risk distraction from running the business which if trading suffers can be fatal. Secondly try to accept that the diligence process is merely a necessary checklist in the process to selling your company. While the demands on your time and patience will likely be just as brutal, the right mind-set will hopefully avoid being blinded by frustration and emotion and avoid unnecessary friction with the diligence providers or the buyer – after all they are just doing their job, and asking what they deem appropriate questions to support the acquisition of your business.
Planning to put your best foot forward - and getting the right support
The best way to neuter the pain of diligence is to plan well in advance with your advisors and to identify problem areas, and find ways to resolve them before the process begins, or alternatively present these upfront to the buyer as voluntary disclosures to be considered, thereby avoiding deal issues later in the process when they are discovered. At Red Swan Partners our team have extensive experience from growing and selling their own businesses, being TIC corporate’s M&A executives, as well as working with a wide range of TIC business owners to support them in the development of their own exit strategy. This wealth of relevant market experience allows us to work with business owners to develop the optimum diligence preparation and support you throughout this challenging process to secure you a premium value for your business.
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