In Part 2 we talked high-level about the process of selling a business. We briefly mentioned the due diligence process.
In this part, we discuss the due diligence process in greater detail.
The due diligence process is where many deals live or die, and where the price is firmed up or adjusted. If you can prepare, assemble and clean up the items that go into the due diligence process before it starts, you stand a better chance of getting a smooth sale at a good price.
Step 3. Clean Up Your Act.
Due Diligence. Perform an internal due diligence review. This includes business, legal and accounting due diligence. Assemble all your legal documents and all your financial statements. Have your team go through them with you. This will help define problem areas, and help you focus on how to resolve them. Pay special attention to due diligence issues affecting key vendors and suppliers, strategic partners, key contracts and key intangible assets, such as intellectual property.
This “internal” due diligence review is done in advance of the “external” Due Diligence Period discussed in Step 2. This is your chance to get things ready for review by the buyers, bankers, accountants and lawyers in the transaction. During the “external” Due Diligence Period, the buyer will perform their own rigorous due diligence review. They’ll want to talk to your vendors, customers, and strategic partners. Doing an internal review in advance of the Due Diligence Period allows you to preview what the buyer will see. It also gives you time to prepare for the inevitable buyer’s due diligence request.
Clean Up Your Financial Statements. The buyer will scrutinize your financial statements to analyze the financial performance of your company over time. Be sure your financials are cleaned up before the buyer requests them at the Due Diligence Period. Consult with your professional advisors as to what financial information the buyer will request, so you can be prepared.
Clean House. Your due diligence review will likely unearth some problem issues. Maybe you forgot to make an annual corporate filing. There may be a contract dispute. A threatened or pending lawsuit. You may have failed to comply with corporate law issues. Maybe there is a regulatory compliance issue. Perhaps a disgruntled employee raises a potential employment law claim, or an independent contractor wasn’t paid in full. Take the time and spend the money to settle these issues, so as not to jeopardize a sale.
Add Backs. Many small family-owned businesses are set up as Subchapter S corporations. The accountants do this to maximize tax savings to the owners. Cars, club memberships, vacation homes, and other items are frequently run through the company. But this has a negative impact on the company’s balance sheet, and the understandable desire is to try to remove those items to show a better financial presentation. I’ve often heard an owner discuss with the buyer and accountants that certain items should be added back, as they won’t be incurred any more after the closing. One or two add-backs might be acceptable, but too many may cause the buyer to move to the next acquisition candidate on their list.
Get Out In Front of Problems. If there are problems you can’t fix, be sure to tell the buyer about them early on, before the buyer finds them for him or herself. If the buyer’s business team doesn’t find the issue, the buyer’s legal and accounting team probably will. Failure to disclose important business problems will undermine your credibility with the buyer at the very least. It may kill your deal. Or set you up for post-closing litigation.
Consider Improving your Value. Improved company value usually (but not always) equates to a higher purchase price. Improving the value may include many things. It may be as simple as resolving the problems you found during your due diligence clean-up. It may also mean making some overdue cuts in personnel, overhead, or other expense items.
Be aware, however, that some spending cuts may increase EBITDA, but actually reduce the valuation. Similarly, postponing the sale to increase revenue may not increase the overall valuation.
Remember to assess owner compensation from a buyer’s point of view. Many privately-held businesses have owner perks, such as cars, airplanes, club memberships, travel perks, etc. Consider reducing or removing these items in advance of the sale. You don’t want to have to explain to the buyer how these items can be added back into cash flow.
Your Second Decision Point.
After performing the due diligence review and cleaning house, you have a chance to review your decision to sell. You may decide, after this review and cleanup, that you’d rather keep your business, and implement some new initiatives, and perhaps sell in the future. That decision in itself might be the best result from going through this process.
In the next part, we’ll look at ways to manage the terms of the sale – if you still want to sell your company.