The Dreaded Due Diligence
It can be a dumpster fire...unless you're prepared for it!
Have you been through a business transaction? Well, I have - about 100 times. It’s great! The thrill of finding the buyer, negotiating the terms, your dreams about to come true. If you have been through a business transaction then you know very well what Due Diligence is. If you haven’t, you need to read on to learn more about this potentially dangerous, but necessary, part of any transaction.
The Deal Process
The normal “deal process” looks something like this: The seller (or investment banker or business broker) provides a little information about the company for sale (the “teaser”). Interested parties sign a non-disclosure agreement, and then get a more detailed view of the company, including financial information among other things (the “deck” or Confidential Information Memorandum, also known as a “CIM”). After reviewing the CIM, the buyer makes an offer to purchase the business, subject to due diligence (the Letter of Intent or “LOI”). After negotiations on the terms of the LOI, you move into the Due Diligence (“DD”) phase.
According to Investopedia.com, due diligence is an investigation, audit, or review performed to confirm the facts of a matter under consideration. In the financial world, due diligence requires an examination of financial records before entering into a proposed transaction with another party. The theory is that the seller opens the books and records to the acquirer for the purpose of confirming that everything the seller represented is true and accurate so that the transaction can close. However, if the buyer uncovers new information during due diligence, this gives them the opportunity to change the purchase price before closing. It’s been said that due diligence is nothing more than a fishing expedition to lower the purchase price. In my experience, that’s exactly what happens most of the time. I have even named the price adjustment conversation… I call it the “re-trade.” Many deals fall apart during the re-trade because it comes as such a shock to the seller. However, if you’re prepared, you can significantly reduce your chances of the dreaded re-trade conversation.
The Nuts and Bolts
Typically, after the buyer and seller agree to the terms of the LOI (letter of intent), the seller will send a comprehensive list (subject to additions) of the things they want to examine during due diligence. For very small businesses and individual buyers, I’ve seen DD requests with as few as 25 items. For bigger companies with more sophisticated financial or strategic buyers the lists are much longer and the details can be excruciating. I’ve seen lists with 175 items and more. (learn more about the types of buyers in the ebook Business Transition Options on our website) The DD list will include tons of financial, operational, customer, vendor, legal, and sales & marketing information requests. The better prepared you are in advance, the smoother the process will go. I’ve seen due diligence drag on for six to nine months when the seller has not prepared the information in advance. One thing is for sure, the faster you produce the information requested, the smoother the process will go.
How do I do that? Prepare for DD far in Advance
It really all starts with defining the ideal outcome for the business transition by having a clear exit strategy years in advance. We say that a great exit strategy is really a great business strategy. A great exit strategy provides clues on other strategic decisions in the business. For example, if a business owner knows they are planning to sell the business to insiders (perhaps management, employees, or family), they can prepare them in advance for that transition. If a business owner plans to sell to a third party, they can develop a strategy to make the business more attractive to potential suitors in the future. Business owners that can clearly articulate the exit strategy typically have a clear vision and drive results.
Regardless of the desired outcome, we always say that business owners should manage their business like they are going to own it for 20 more years. The business should drive operational excellence by clearly documenting the critical processes in the business ( The financial statements should be clear and understandable. If you show your financials to your banker, and they ask lots of questions about what the line items mean, perhaps it’s time to simplify them so they are easy to read and understand. If you have any pending legal matters, get them resolved quickly. While it might be tempting to fight a lawsuit on principle, typically the lawyers are the only winners. Get your corporate records in order and make sure you’re following all of the regulations regarding corporate governance for your type of business. And above all, if there are “warts” in your business, don't try to hide them. A sophisticated buyer will always find them, and that will add fuel to the re-trade argument.
Of course, the easiest way to prepare in advance is to let us help you at Mastery Partners. This is what we do. Our Transition Readiness Assessment (TRA) examines the business from every angle, and we can tell you how ready you are for a transition as if it were happening tomorrow. Our TRA report will tell you what you're doing right, what needs to be tweaked, and what you should start doing or stop doing. Call my cell or schedule a call with me
if you’d like to learn more about that.
Managing Due Diligence
Of course, if you’re prepared, you’ll have at least 90% of the information you’ll need to produce right at your fingertips, and you should be able to produce the rest very quickly. If you’re not prepared, it will take weeks to gather the data, which can be very distracting for the business owner and the team.
Remember, the faster you can produce the requests, the faster you will get through the due diligence maze. And, if you’re selling your business to a financial or strategic buyer, expect the re-trade conversation, and be ready to negotiate… again.
So, stop right now, and go think about your ideal desired outcome. If you truly desire to sell your business someday, then you need to start preparing now. At a minimum, you should think about having our Transition Readiness Analysis performed so you know how ready you are.
How ready are you for a transition? Can you clearly articulate your exit strategy and desired outcome? Let me know if you need help because that’s what we do. Being prepared will have more impact on your business value than you think! What are you going to do today - to Maximize Business Value?
Tom Bronson is the founder and President of Mastery Partners, a company that helps business owners maximize business value, design exit strategy, and transition their business on their terms. Mastery utilizes proven techniques and strategies that dramatically improve business value that was developed during Tom’s career 100 business transactions as either a business buyer or seller. As a business owner himself, he has been in your situation a hundred times, and he knows what it takes to craft the right strategy. Bronson is passionate about helping business owners and has the experience to do it. Want to chat more or think Tom can help you? Reach out at email@example.com or check out his book, Maximize Business Value, Begin with The Exit in Mind (2020).
Mastery Partners, where our mission is to equip business owners to Maximize Business Value so they can transition their business on their terms. Our mission was born from the lessons we’ve learned from over 100 business transactions, which fuels our desire to share our experiences and wisdom so you can succeed.