Values-Based Due Diligence

By Generational Equity


In past articles we have discussed some of the various forms of due diligence that professional buyers use prior to making an acquisition. Some of the more common forms of due diligence include IT, financial systems and reporting, HR policies and procedures, environmental, and legal. The overall goal of these various forms of due diligence are to ensure that the buyer is comfortable with all the key aspects of the target they are acquiring.

If you are negotiating a deal on your own without the help of an M&A consulting firm, you should be prepared to answer anywhere from 100 to 300 questions during a 60- to 90-day period and be ready to spend extensive time with the due diligence teams that the buyer may bring in.

Keep in mind that each of the segments of due diligence usually requires a specific area of expertise (legal and accounting, for example), which means you will most likely be dealing with several different groups within the acquiring company.

According to Axial (a leading network that works to help capital providers connect with business owners), a new form of due diligence is becoming more and more important, especially for private equity groups: values-based due diligence. Although this form of due diligence has been done informally for years, professional buyers are now making it a larger part of their formal process.

According to Kevin Coughlin of Coughlin Capital:

“One of the most important things we do when speaking with a business owner is to ensure that we have an understanding of their business values and the end-result of the desired transition. Our values, with regard to how the business will be run, need to align. If they do not, it can cause significant headaches and hurdles in the future. If the values are clearly conflicting, it’s a non-starter.”

Simply put, both the buyer and the seller need to be very comfortable with the current values of the target as well as where the new buyer will be taking the company philosophically in the years after the acquisition. This mutual compatibility cannot be stressed too heavily.

The Legacy and the Future

One of the most enjoyable parts of my job is meeting with our clients post-sale and interviewing them about the Generational Equity process. Invariably when the discussion turns to how the final suitor was chosen, compatibility often trumps everything, including – in many cases – the final price and deal structure. It is amazing how often our clients tell me that at the beginning of the process, deal value and structure were the most important issues to them. However, as the sales process narrows and sellers begin to visit with buyers, our clients begin to realize that the legacy they are leaving behind and the success of the company going forward is dependent on who the buyers are and how their belief set and philosophies align with the seller’s.

Buyers tell us the same thing, especially private equity firms that specialize in investing in lower middle-market companies (typically companies valued below $100 million). Over and over the idea that the values of the sellers, and the company they have built based on those values, need to be in line with the philosophy and goals of the acquirer. If they are not, more often than not, professional buyers will simply walk away from a deal. To quote Kevin Coughlin again:

“We would prefer to walk away from a good deal than do a deal that would fail.”

On the surface, this concept of mutually aligning the philosophy and practices of an owner as they relate to how vendors are treated, employees are led, customers are valued, and existing and new owners will interact seems quite simple. However, in practice, it can become quite complex and will often scuttle a transaction far sooner than some of the other due diligence processes mentioned above.

One major problem that we often encounter with our clients is that many do not have a stated business philosophy, mission statement, or any documentation about their strategic growth initiatives. Often our first step is not only establishing the initial value of the company but also encouraging the owner(s) to begin thinking about how he or she will articulate the philosophy and mission of the business to any potential buyers.

Of course the real goal of due diligence from a buyer’s perspective is to “test” all the facets of the organization so that the odds of post-acquisition success are higher than if no due diligence was performed. If your business is not prepared at all for due diligence, chances are good you won’t even get that far with a buyer.

Time and space do not allow us to flesh out all of the facets of due diligence. If you would like to learn more, attend a Generational Equity complimentary M&A workshop. Entitled, “How and when to exit your business for the most profit: A planned exit strategy,” our seminars are designed to help business owners protect their largest financial investment and exit under terms that are favorable to them, not the buyers.