Many Texas business owners we speak with feel that securing a serious offer from a qualified buyer is the largest hurdle in realizing the sale of their business. However, once they have agreed to pricing and terms, a equally if not more critical next step presents itself – the arduous process known as due diligence.
Due diligence is the confirmatory period where the party investing or acquiring your business seeks to understand all aspects of the company. This entails pouring over financial statements (historical annuals and monthlies) to understand key items like revenue and profitability trends as well as deeper details like cash flow, inventory turn and normalized working capital requirements. Due diligence also happens to be statistically where most transactions fall apart. Buyers will also want copies of all contracts relating to the business including leases, employee agreements, software licenses, bonus plans, health coverage, royalty agreements, distribution agreements, supplier agreements and more depending on the business you are in and the key motivations of the buyer.
In addition to the above items, a savvy buyer will want to see financial projections, defined growth opportunities and may even want to visit with members of the senior management team, major suppliers and key customers. While business owners in smaller, niche or local Texas markets are often very protective of critical business information, once diligence starts, the business owner may need to comply in order to secure or defend the agreed upon value of the business. (Managing due diligence requires balancing the needs of the buyer with your need to protect your business. Consult with your M&A advisor before granting buyers access to sensitive information including customers, suppliers and management.)
This may seem overwhelming, but consider viewing the transaction from the buyer’s perspective.
M&A is not like the stock market. Buyers are considering purchasing a non-liquid asset and they need to understand the business as clearly as possible so that they can mitigate risk and ensure their return is up to the standards of their investors or limited partners. The result of this intense period of business scrutiny is that issues are often discovered that can limit value or, worse, disrupt the entire transaction.
The benefit of hiring an investment banker to help you through the sale or capital raising process is that you can discover these issues early on by doing an extensive amount of pre-diligence. Properly executed pre-diligence can lead to faster close times and reduced cost of post LOI due diligence. Additionally, hiring an investment banker or M&A advisor who has experience specific to your industry or location can help integrate a perspective on due diligence into your transaction that may be the key to ensuring the transaction is a success.
Prior to marketing your business to potential investors or acquirers your business investment banker or M&A advisor should take you through the complete due diligence process as they investigate about all aspects of your company through developing the Confidential Information Memorandum (CIM). This may seem tedious and gathering all of the data and documents will take time, but catching any potential issues early on and strategizing with your investment banker on the best way to diffuse them will be invaluable later on in the business sale process.
Disclosing any issues and avoiding value-lessening surprises is a huge credibility booster in the eyes of buyer and investors, which is paramount to maximizing value.
Legal diligence is also something that should be handled on the front end of the transactions process. Ensuring that all contracts that need to be transferable or assignable are indeed transferable or assignable and that any litigation clouding the company is resolved can save a deal.
Environmental diligence can also be important, especially for businesses that involve chemicals, speciality materials or fossil fuels as is so often the case here in one of the oil and gas production hubs of America. Making sure the facility and process are all up to regulation is important. A major environmental issue that affects the business or the real estate can certainly be a deal killer.
Employment issues can be tricky to head off early on, because in most cases you do not want your employees to know the company will possibly be sold. However, making sure all employee agreements are solid and ensuring there are no potential grievances will only make your transaction go smoother.
Pre-diligence, the process of preparing yourself for due diligence, will help mitigate the risk of deal failure and will better prepare you and your company for the involved process that closely follows accepting an offer.