Buyer due diligence is arguably the most critical step in the Mergers and Acquisitions (M&A) process. Before a buyer writes you a large check, the buyer will engage financial, tax, legal, insurance, and other specialists to conduct a comprehensive evaluation of your business to validate that the business is ‘as represented,’ and to ensure post-closing risks are sufficiently mitigated. The level of scrutiny is greater on stock purchase transactions (as opposed to asset purchases), as in the former, buyers assume all assets and liabilities, disclosed or not.
Due diligence typically takes 30-60 days (or longer in the current lending environment). Sellers receive checklists containing hundreds of questions across various diligence tracks. Buyers expect responses within 24-48 hours, so it’s essential that sellers be prepared and respond transparently and concisely. M&A Advisors play an integral role helping the seller prepare for diligence, ideally planning months or years before going to market. During diligence, the M&A Advisor helps the seller prepare sufficiently detailed responses and acts as the project manager, keeping the process moving forward.
Experienced M&A Advisors go a step further – they anticipate buyer questions, perceive the intent behind questions, and assess potential ramifications of responses. The questions below illustrate how savvy buyers pose diligence questions to uncover latent risks:
- Can you provide monthly GAAP (Generally Accepted Accounting Principles) financials for the past 3 years?
- Intent – To understand trends, seasonality and unusual fluctuations not always reflected in annual financials and to confirm that the seller has a competent finance team with industry knowledge.
- Have you had any litigation in the past 5 years or litigation pending?
- Intent – To assess potential exposure and uncover patterns in management’s behavior.
- Have you compensated staff in a way not reported on W2/1099?
- Intent – Assess potential risks of sellers compensating staff in unconventional ways that may not be reflected in financials/filings. Could kill deal if not mitigated properly or transparently disclosed
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- Provide all agreements with customers, suppliers, employees, and business partners.
- Intent – To evaluate all agreements to assess risk and transferability. Can be a deal killer for sellers that operate on handshake agreements.
- What are your client relationships like and what role do you personally play?
- Intent – To understand owner responsibilities. If owners’ personal customer relationships are essential for continued success, buyers perceive additional risk that may lead to a price reduction or adjusted terms.
- What is your growth plan and what do you need to achieve this?
- Intent – Sellers commonly think in terms of revenue but not necessarily of costs required to achieve growth. Buyers look for concrete plans that include incremental labor, equipment, or facilities and in the absence, may seek price concessions.
Upon signing the Letter of Intent (LOI) and commencing diligence, professional buyers spend several hundred thousand dollars on diligence teams that are trained to surface potential issues. All businesses have some deficiencies and buyers understand and expect this. However, when these warts are discovered (and they will be discovered), buyers expect sellers to be fully cooperative and transparent. Ultimately, aside from validating the business is ‘as represented’, diligence is a way for buyers to assess whether they want to be in business with the seller. Sellers are well-served to engage a strong deal team (experienced M&A Advisor, CFO/CPA and a seasoned transaction attorney) who can collectively help them emerge unscathed from diligence!
As you consider selling your business, we encourage you to speak with an experienced
M&A advisory firm that can increase the odds of your transaction closing successfully.
Kinected Advisors has an 88% success rate in our transactions, well above the 20-30% industry average. We would love to speak with you about getting you the best possible deal for your business.
Kevin leads sell-side M&A engagements for businesses with $10M–$100M in revenue. He has advised on ~$1B in transactions and can be reached at kevin@kinected.com.