A couple of articles ago we explored the contents and importance of a Letter of Intent (LOI) in an M&A event. As you may recall, the LOI is the document that the buyer and seller negotiate and then sign which triggers the next and most important portion of a deal closing: Due Diligence.
This 2-3 month period is where most deals collapse for a variety of reasons. Sellers get fatigued by the ongoing, unceasing back and forth with buyers on a variety of topics; buyers lose momentum because of a lack of information being fed back to them or inaccuracies and inconsistencies in the documentation.
It is a serious time in any transaction and unprepared sellers often have a very tough time going through due diligence. This how our friends with Axial describe it:
At its core, due diligence is about uncovering and evaluating risk. During the process, acquirers try to confirm the accuracy of the information the company has provided, as well as unearth any potential risks not detailed — whether intentionally or unintentionally. In addition to reviewing the paperwork the company provides, most acquirers will also do some form of on-site due diligence in order to speak with company employees and get a better sense of how the organization functions on a day-to-day basis.
I have highlighted the end of the first sentence above because ultimately the level of risk a buyer sees in your business will serve to increase the discount rate the buyer will apply to your future earnings. This in turn, all things being equal, will reduce the payout when the deal closes and/or impact the terms of the deal.
In some cases, if the risk is considered substantial, you may be required to stay with the firm for 3-5 years under an earn-out tied to revenue and/or earnings targets being hit (some of which you will not have direct control over).
So how do buyers evaluate risk during due diligence? As Axial reiterates, by closely analyzing key areas such as:
Business/operations: How sustainable is your company’s revenue and cash flow? What is your growth trajectory? How do your customers view your product/services?
Accounting: Most acquirers will conduct a “Quality of Earnings” review of the sellers’ financial statements (usually with the help of an outside accounting firm) to arrive at a comprehensive understanding of the target’s historical revenues, cash flows, and earnings.
Legal: Acquirers will engage a lawyer to review a variety of legal documents — including organizational documents, customer/supplier contracts, past litigation, real estate leases, and more — to look out for any current or potential legal liabilities.
IT: IT due diligence varies depending on the type of company, and will obviously be more extensive for software or tech-enabled businesses. A few common focuses include security vulnerabilities, ownership/structure of proprietary technology and/or custom software, and software and employee device inventories.
Environmental: What environmental risks are associated with the business? Depending on the company’s industry and risk factors, acquirers will conduct environmental site assessments of any company properties to determine potential contamination, litigation risks, and more.
And believe me, this is just the tip of the iceberg! Most due diligence punch lists contain 200-300 initial questions with, as the process unfolds and risk factors are identified, dozens of follow-up queries.
So preparation by the seller is critical. The worst thing you can do as a seller is not have your documents in order and delay getting back to the buyer in a timely manner. That in and of itself is a risk factor that makes buyers cringe.
Since due diligence can be so difficult to navigate, we strongly recommend that sellers engage an experienced M&A firm long before you reach that stage. Our clients often tell us that they had no idea going into it how challenging it would be and how, without our assistance, close to impossible it would have been to survive. Don’t take my word for it, have a listen to a few of our clients about it:
In these videos the two key themes you hear are:
Our process begins with a full evaluation of the firm by our award-winning evaluation team. This 3- to 4-month process is really a mini version of the due diligence you will have to eventually endure. Not only do we place a value on the company, but the questions we ask are also very similar to what buyers will ask. So for us, it becomes a key part of the eventual success in closing the deal.
If you are interested in learning more about the services we provide to business owners, give us a call at 972-232-1121 or visit our web page, give us your contact info, and we will reach out to you.
And if you decide to work through due diligence alone without help, remember to be prepared in advance to answer tough questions that are designed to ferret out risk. If you are not prepared, they will find it!
Carl Doerksen is the Director of Corporate Development at Generational Equity.
© 2019 Generational Equity, LLC All Rights Reserved
it all started with a conference.
start your story today,
speak directly with one of our senior advisors +1-972-232-1121
The information we learn from customers helps us personalize and continually improve your experience. Here are the types of information we gather.
We receive and store any information you enter on our Web site or give us in any other way. We do not sell or rent your personal information to others without your consent. We use the information we collect only for the purposes sending promotional information, enhancing the operation of our site, serving advertisements, for statistical purposes and to administer our systems. We DO NOT use third parties to provide customer service, to serve site content, to serve the advertisements you see on our site, to conduct surveys, to help administer promotional emails, or to administer drawings or contests, but reserve the right to do so in the future without advance notice.
Generational Group’s affiliates are all part of one corporate family, they work with one another and may work together to provide services to you. The sharing of your information among affiliates enables Generational Group to serve you more efficiently and makes it more convenient for you to do business with Generational Group. Generational Group is permitted by law to share information with its affiliates. All of our affiliates follow similar privacy policies.
For reasons such as improving personalization of our service, we might receive information about you from other sources and add it to our account information.
Generational Group may license the use of its intellectual property including but not limited to its name, likeness, and logo for the use of affiliated offices. Such affiliated offices may not be owned, controlled, managed, supervised or staffed by employees, officers, or agents of Generational Group. Affiliated offices may be independently owned and operated. For more information about a particular office, please contact Generational Group at its office in Dallas, Texas.
This page may contain other proprietary notices and copyright information, the terms of which must be observed and followed.
Information on this web site may contain technical inaccuracies or typographical errors. Information may be changed or updated without notice. Generational Group may also make improvements and/or changes in the products and/or the programs described in this information at any time without notice.
Generational Group does not want to receive confidential or proprietary information from you through our web site. Please note that any information or material sent to Generational Group will be deemed NOT to be confidential. By sending Generational Group any information or material, you grant Generational Group an unrestricted, irrevocable license to use, reproduce, display, perform, modify, transmit and distribute those materials or information, and you also agree that Generational Group is free to use any ideas, concepts, know-how or techniques that you send us for any purpose.
Our computer system protects personal information using advanced firewall technology.
Information Generational Group publishes on the World Wide Web may contain references or cross references to other products, programs and services that are not announced or available in your country. Such references do not imply that Generational Group intends to announce such products, programs or services in your country. Consult a Generational Group representative for information regarding the products, programs and services which may be available to you.
Generational Group makes no representations whatsoever about any other web site which you may access through this one. When you access a non-Generational Group web site, please understand that it is independent from Generational Group, and that Generational Group has no control over the content on that web site. In addition, a link to a non-Generational Group web site does not mean that Generational Group endorses or accepts any responsibility for the content, or the use, of such web site. It is up to you to take precautions to ensure that whatever you select for your use is free of such items as viruses, worms, Trojan horses and other items of a destructive nature.
IN NO EVENT WILL Generational Group BE LIABLE TO ANY PARTY OR ANY DIRECT, INDIRECT, SPECIAL OR OTHER CONSEQUENTIAL DAMAGES FOR ANY USE OF THIS WEBSITE, OR ON ANY OTHER HYPERLINKED WEBSITE, INCLUDING, WITHOUT LIMITATION, ANY LOST PROFITS, BUSINESS INTERRUPTION, LOSS OF PROGRAMS OR OTHER DATA ON YOUR INFORMATION HANDLING SYSTEM OR OTHERWISE, EVEN IF WE ARE EXPRESSLY ADVISED OF THE POSSIBILITY OF SUCH DAMAGES.
Furthermore, all information contained within this website is the property of Generational Group.
Success, you have been added to our list.