Due Diligence: Preparation is Key
Last week I wrote a blog that focused on the value of preparation in the sale of any business. This week’s post will continue in that theme. This time regarding a key part to any business sale: due diligence review. In our blog post from December 30th, Corrie discussed the importance of due diligence and provided some excellent resources for anyone interested in learning more about the process. Check it out here.
I am not going to rehash the importance of due diligence here because I am assuming you understand that it is extremely important. Instead, let’s focus on how to prepare for due diligence and how preparation (or lack thereof) can make or break a deal.
According to the Harvard School of Business, between 70% and 90% of all M&A deals fail. This number goes up and down depending on the size of the business deal, but the research shows that this trend applies across the board. Any number of things can cause a deal to fall apart, but there is one common factor that plays a role in many failed deals: TIME. A common adage in sales is that “time kills all deals” and that applies to M&A deals too. Once a purchase offer is accepted, both buyer and seller have a list of tasks to complete before closing; it is then the clock begins ticking. The longer it takes to get from offer to closing, the more chances there are for the deal to fall apart. Parties can start second-guessing their sale terms or begin thinking about renegotiating the price. For example, unexpected things can happen (such as a global pandemic) that can hurt the business profits and plummet the value. The future is never certain, so the quicker you can close, the better chance you have of avoiding potential pitfalls.
The closing process has many moving parts and involves a “village” of attorneys, accountants, bankers, and other experts. You will not be able to control all of those people or how long it takes them to do their work, but due diligence is one factor that the buyer and seller control, and it can make or break a deal. If a buyer can present a clean, carefully considered list of requests, and the seller can quickly provide everything requested, the diligence process can be very smooth and pleasant. Things go awry though when buyers make excessive requests that are irrelevant or sellers take too long to provide necessary information. When the diligence process breaks down, it slows down the closing and causes frustration all around. This brings me back to my theme: preparation. A lot of due diligence involves the same key documents and information, and the more that gets done ahead of time, the easier the process can be for everyone.
The best way to streamline the due diligence process is to streamline your request list. Once an offer is accepted, buyers will be asked to provide a list of all items they would like to review for their due diligence. Some buyers submit generic request lists that they received from their lawyer (or that they downloaded off the internet), but that is often counter-productive. Those generic request lists often include hundreds of items, and many of those items are irrelevant or do not apply to the specific deal. However, the seller and their team still have to pore over this bloated list and figure out what they actually have to provide. This leads to unnecessary delays, and it can cause frustration and exhaustion on both sides. Once an offer has been accepted, the buyer should go through their request list and carefully consider what items are actually helpful and which ones are not. Don’t think that you only get one chance to request information. Due diligence is an ongoing process, so it is far better to be judicious with your list and request more details later.
You should consider getting a jump on possible diligence items as soon as you make the decision to sell your business and start marketing it for sale. As a best practice, you should try to prepare the following:
- Corporate documents (incorporation documents, by-laws, organizational chart, etc.)
- Federal and state tax returns for the past 5 years
- Year-end balance sheets and profit & loss statements for the past 5 years (especially if you have not yet filed last year’s tax return)
- Balance sheet and profit & loss statements showing current year-to-date
- Copies of all company contracts (vendors, customers, employees, etc.)
- Documentation regarding any intellectual property of the business
- A list of all equipment, vehicles, and hard assets of the business (with value estimates)
- Copies of any certifications or licenses held by the business
- List of any expected or pending litigation claims against the business
This list is not exhaustive, and every due diligence review is different. However, these are the items that are requested in most every business sale, and any seller should be prepared to provide them upon request.
You may not be able to predict every twist of fate in a deal but being efficient in your due diligence will help everything else go more smoothly. Preparation is key, and the sooner you start, the easier time you will have with the diligence process.
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