By Piers Hartland-Swann
So you’ve reached the point in a sale process where you’ve selected a preferred buyer for your business and agreed heads of terms for the deal. Next, the buyer will want to conduct due diligence, where they investigate your business in detail and confirm that everything you have told them about it (and upon which they have based their deal value and terms) is correct and complete. This typically involves multiple lawyers, financial experts, external advisors (e.g. technical, commercial) and stakeholders from the acquiring company. Myriad issues can spring up as a result. The biggest risk is that the buyer and their advisors unearth unexpected issues, and confidence in the deal declines, leading to delays, adverse changes to the deal terms or in the worst case a failed deal.
There are several things you can do as a vendor to reduce this risk and make the process as smooth as possible. Naturally, this will include working with your corporate finance and legal advisor to identify and gather materials to respond to the likely questions from the buyer. But frequently it can make sense to work with additional advisors to prepare materials to help bolster your case. Although this can be expensive and time-consuming, it will help ensure that the deal goes through on the agreed terms and that your business is sold for what it’s really worth.
Preparing for due diligence
In FirstCapital’s SMART dealmaking framework, execution of due diligence falls into the ‘Transaction’ phase, at the very end of a deal. However, that is really only true from the perspective of the buyer. Vendors should have their ducks in a row well in advance of this, and preparations for due diligence should be made from the beginning.
Some examples of this include working with your legal advisors to review contracts (e.g. with customers or employees) and company records to identify and correct any gaps in documentation. Given that problems identified can take time to fix, it makes sense to start on this as early as possible.
Similarly, your external accountant will be able to help confirm the quality of your financial disclosure e.g. with audited numbers.
The benefits of external advisors
However, in certain cases there can be real benefits for you as a vendor in bringing in other advisors to help with specific areas of due diligence:
- Financial due diligence advisors to help the buyer and their advisors to understand the accounting, tax and finances of the business, answer their questions and diligence it in the most efficient way possible.
- Commercial due diligence advisors to help a buyer who is less familiar with your industry to understand it and the competitive landscape around your company.
- Tax and accounting advisors to help structure the deal efficiently from an accounting and tax perspective.
Using external advisors like these costs vendors time and money, so it can be easy to dismiss their work as unnecessary. However, we frequently see deals where the benefits to the vendor in terms of value, speed and certainty far outweigh the risks of not going through the process. Having your own vendor due diligence reports prepared gives you a greater ability to shape the due diligence discussion and present the information in the format that shows your business in the best light. This helps to minimise the risk that the buyers’ due diligence advisors go off in the wrong direction or focus on something that detracts from your key messages, and potentially exploit this to negotiate less favourable transaction terms.
Things to consider during due diligence
If preparation has gone well, the due diligence process should be smooth. However, bearing in mind some additional points can help you to ensure a positive outcome:
External due diligence advisors can add significant value in private equity deals in particular. Private equity buyers are willing to place reliance on commercial and financial vendor due diligence reports, and it helps them to move quickly in an auction process. The benefit for the vendor is that all bidders receive better information about the business earlier in the process, making the auction more competitive. And, when the preferred bidder has been selected, the due diligence period before completion can be much shorter, which reduces the risk of an adverse change to the agreed deal terms or the deal failing.
Vendors can give international suitors comfort by having their accounts (and particularly accounting policies) reviewed by a big-name firm. Foreign buyers often lack familiarity with local accountants and accounting standards. A financial due diligence report from a leading firm helps to reduce the risk of disagreement between buyer and vendor over the financials that could adversely affect the deal terms.
It does not pay to delay, and in some cases preparations for due diligence need to be made from day one. FirstCapital will always recommend external advisors if we think they are needed, either to reinforce the financial reporting, to provide comfort on the achievability of the forecasts, or to educate a buyer on the market and competitive dynamics that you are operating in. Where appropriate, bringing in these types of external support can make a huge difference, delivering better, smarter deals.