Due Diligence Preparation – Keeping Your Transaction on Track

By Generational Equity

01/15/2014

A veteran deal maker once told me that about 60% of all transactions fall apart at least once, and usually during due diligence. Think about that for a moment. You spend months and months creating your documents, even more time trying to find a buyer, you finally get someone to sign a LOI (letter of intent to purchase your company) and begin negotiating – only to have your potential deal fall apart because of issues that arise in due diligence.

What a travesty that can be. If you are fortunate enough to have an experienced M&A advisor working with you, hopefully this can be avoided. Even so, if something does come up, he or she will be able to work with you to right the process and get the deal back on track.

The key, of course, is preparing well in advance of the due diligence process on your company. Far too often business owners who are not represented by professional M&A advisors simply do not do their homework prior to due diligence and pay the price in the end when their deal falls apart.

Rushing to get to market can be caused by age, illness, burnout, divorce, legal problems, partner squabbles, and a myriad of other reasons. Rushing could significantly impact your ability to get an optimal deal for your company.

The Due Diligence Check List

So just what is due diligence when it comes to the sale of a business? It is the phase of an acquisition that begins once you and the buyer have signed a letter of intent. You will be required to turn over every document you have that proves how your business operates. As you can imagine, if a seller is not prepared in advance, the due diligence phase can drag on for months, and in many cases, if it does, buyers get cold feet and will move on to other, more attractive opportunities.

First and foremost, you never want to spend several months in due diligence with a buyer to have the deal fall apart. Not only is this emotionally heart-wrenching but it also exposes your business to risk, as you have lifted the veil to your company’s innermost operations, and even though you have signed agreements from the buyer about the use of the information he/she is obtaining on your company, there still is risk that proprietary information could be used.

How do you avoid this? By taking the time and putting in the effort far in advance to ensure that your company is ready for intense buyer scrutiny. According to several sources, here is a partial list of some of the items you will be required to provide in due diligence:

• Organizational documents – company bylaws, organizational chart, list of assumed names, etc.
• Financial records – 3 years historical and 5 years projected income statements and balance sheets
• Mortgages, deeds and leases
• Licenses, permits and letters of consent
• Press clippings and releases about your company
• List of physical assets
• Copies of contracts and other agreements
• List of professional service providers
• Employee documents – resumes, contracts, salaries, benefits, personnel records, and employee handbook
• Copies of litigation – past and pending
• Insurance policies and claims
• Warranty claims or complaints
• Regulatory compliance letters
• Proof of environmental compliance (if necessary)
• Engineering reports
• Customer feedback and surveys
• Patents, copyrights, or work-for-hire agreements
• Customer data – especially for any customer generating more than 10% of revenue
• Market research and advertising campaigns
• Sales policies, return policies, credit policies, and service agreements

Keep in mind that this is just a partial list. We have seen due diligence punch lists that have more than 200 items on them. A list of that nature can be daunting and very, very time consuming. Again, the key to a successful due diligence process is having the documentation ready in advance. If you do not have professional representation, you need to look at your business as if you were a buyer. Ask yourself, what would I need to know about this company if I were buying it? What would make it possible for me to have confidence about its operations going forward?

Never assume that just because you are trustworthy and have created and grown a great business that a buyer will see you that way. Professional buyers, folks that make multiple acquisitions, won’t take your word for anything. They want to see documentation, evidence that your company is capable of doing what you claim it will do in the future.

If you don’t have an experienced M&A firm working for you, at a minimum you will need an accountant and an attorney who have both worked on transactions before in your corner. And you need to plan on spending at least three months or more preparing your due diligence documents. If you look at the list above and feel daunted by the details, then you really need to start preparing today to get all your information in order for buyers to review.

The reality is, a buyer-ready business is one that has been prepping for due diligence from the day the business first opened. A well run company will have most, if not all, of the items on the list above at hand because all of those items make good business sense to regularly document. In fact, quite often as we do our own due diligence on our clients (also known as our evaluation phase), it is amazing how often clients realize that they have a really well run company once it is all documented.

No matter what, please take the time to prepare for due diligence far in advance. By doing so you will ultimately save yourself from the anguish of a buyer walking away during due diligence due to a lack of documentation.

One of the most important issues you will need to face as a business owner is the eventual succession of your company into another person’s hands. It is far better to prepare for this eventuality far in advance rather than having circumstances out of your control force you to make this transition. Fortunately Generational Equity is here to help. We have developed a one-day workshop designed to enable business owners to begin their exit planning process. By spending just a few hours with us you will learn a significant amount about the entire M&A process, not just due diligence. 

Carl Doerksen is the Director of Corporate Development at Generational Equity.

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