How Transactions Fail and How Pre-Diligence Can Help
Many M&A transactions fail during exit planning due to poorly or hastily executed due diligence. Do not underestimate the importance of due diligence: the M&A deal depends on it.
The Importance of Due Diligence in an M&A Deal
Due diligence is a process that examines every aspect of the target company (i.e., the company to be sold) to assure the buyer that it is a sound investment. The due diligence involves a thorough audit of the target company’s financial records, contracts, agreements, sales, operations, structures, etc.
Due diligence reporting encompasses environmental risks, analyses of assets and liabilities, identification of industry and company-specific risks, unearthing accounting irregularities, scrutiny of legal contracts and agreements, cash flow considerations, financial sustainability, future potential, and much more. This investigative process helps prospective buyers identify potential risks before entering the M&A deal or proves that the target company is a good fit. It gives them peace of mind, allows them to make an informed decision, and ensures that they enter into the right deal.
Due diligence helps buyers make informed decisions and, at times, is responsible for M&A deals falling through. As a business owner wanting to sell your business, due diligence is also your primary concern. You need to ensure that your company passes the due diligence stage of an M&A transaction.
Due diligence benefits the seller, too, by providing an in-depth analysis of the business’s financial integrity and helping uncover the company’s fair market value.
What Is Pre-Diligence or Pre-Due-Diligence?
Before starting your business sale journey, go through the pre-diligence process. This acts like a pre-flight security check to ensure your business smoothly passes through the due diligence stage of an M&A transaction.
So, by performing seller’s due diligence before putting your company on the market, you strengthen your interests as a business owner by identifying and correcting potential deal-breakers.
5 Top Tips for Pre-Diligence
- Keep all the data for due diligence in one place.
- Keep due diligence documentation organized.
- Take guidance from an advisor.
- Document adjustments to EBITDA.
- Make the necessary adjustments to net working capital.
1. Keep All the Data for Due Diligence in One Place
Collect all the required documents and store them in a safe place. Maintain a due diligence checklist to avoid missing anything. A due diligence checklist usually involves the following categories:
- Products and services, customer information, tax information
- Real estate, physical assets, intellectual property
- Information on employees and benefits, financial information
- Articles of incorporation and shareholding documents
- Revenue streams, licenses, and permits, environmental issues, materials contracts
- Litigation documents, insurance coverage, outsourced professionals like accountants, lawyers, consultants,
- Marketing efforts, IT concerns, antitrust, and regulatory issues.
Each category consists of several documents critical for due diligence. Take guidance from exit planning advisors to remove irregularities, identify and eliminate risks, and gather the information essential for a smooth due diligence process.
2. Keep Due Diligence Documentation Organized
Organizing all the required documents makes them readily available, ensuring transparency when the buyer’s advisors conduct their due diligence. Also, keep all the documents up-to-date and error-free.
Pre-diligence efforts make your company look professional and efficient. It makes your company an attractive target in the eyes of the buyers, and you gain their confidence.
3. Take Guidance from an Advisor
Use specialists in the M&A process to assist you with financial, legal, and tax matters. They contribute unique perspectives that help identify irregularities and risks and fix them; prospective buyers conduct their due diligence.
Your advisor will prepare you for the hundreds of potential questions the buyer’s due diligence team may ask. They can also help bring more buyers to the table and open new opportunities for your company.
4. Document Adjustments to EBITDA
If you treat your EBITDA adjustments in the same way as you view your tax adjustments, you will likely lose credibility in the eyes of potential buyers. Even if your CFO recommends such adjustments, keep documented proof supporting them so that you can provide the evidence to the buyer’s due diligence team.
5. Make the Necessary Adjustments to Net Working Capital
Make appropriate changes to your capital if it’s trapped in networking capital because you’ll need to prove that your business can operate with lower working capital. Work with your advisors to ensure no significant leaps and declines in the calculating net working capital.
How Pre-Diligence Helps to Avoid Transaction Failure
Do not overlook due diligence. Prospective buyers will scrutinize all aspects of your business before deciding, so invest time to ensure that they see the best of your company’s operations, financial situation, structure, potential growth, accounts, documentation, etc. For further deal insurance, consider getting a Quality of Earnings (QoE) Analysis conducted by a qualified third-party expert.
Pre-diligence helps you identify and eliminate risk areas in your business, maximizing your business value and appealing to buyers. It also saves you crucial time by uncovering and fixing issues that would take longer to resolve if left unattended. Resolving issues before taking your company to market saves you time, money, and effort.
Pre-diligence safeguards your selling price by eliminating things that could reduce it. As a business owner, it protects your goal to achieve your desired exit. It ensures that your documents, representations, and warranties are error-free and that your records will not lead to losses for the buyer. It prevents you from damaging discrepancies the buyer may ask you to compensate.
Key Takeaways
Many M&A deals fail at the due diligence stage. Buyers take due diligence seriously and employ savvy advisors to conduct it thoroughly and accurately. The due diligence report can make or break an M&A deal, so you, as a business owner, should not underestimate its importance.
Prepare well to derive positive outcomes from the due diligence process, which can be highly complex, time-consuming, and involve hundreds of documents. Work with experienced exit planning advisors to ensure that your business successfully passes the buyer’s due diligence.
The number one deal killer? The owner’s perception of risk related to operating their company is almost invariably lower than an outside buyer’s perception. To ensure a successful sale, Founders need to be able to break through to the next level to de-risk their business, maximize their valuation, and reduce founder dependency. Get in touch with Quantive’s Business Performance Group for a no-cost consult for your business.
