Published on February 2, 2023
Have you ever been to the dentist and during the cleaning the dentist seems to want to keep digging deeper and deeper below the gum line. Well, welcome to due diligence! For those that have never experienced this, the due diligence process, most likely is not going to be a pleasant experience, but is part of a process, and it is an important part of the sale process in determining the success of a deal. If you are selling your business, it is important to understand what to expect during the due diligence process and not wait until you are in a chair looking up at a light to find out what is about to happen…. ask questions in advance and do all you can to prepare for it.
What is due diligence? Due diligence is the process of thoroughly evaluating a business before a sale or investment. It is designed to identify any potential risks or issues that may impact the value of the business and to provide transparency to the buyer. The due diligence process typically includes a review of the financial, legal, IT, HR, and operational aspects of the business, but depending on the type of business may and environmental due diligence and more.
Who conducts due diligence? Due diligence is typically conducted by the buyer, who may hire a team of professionals to assist with the process. This team may include accountants, lawyers, and industry experts, depending on the specifics of the deal. The seller or the seller's team, if not prepared in advance, might be very involved in the process, providing information and answering questions as needed as things progress.
What is reviewed during due diligence? The scope of the due diligence process will vary depending on the specifics of the deal such as the deal size along with the nature of the business. However, common areas of review include:
Financial information: The buyer will typically review financial statements, tax returns, and other financial documents to assess the financial health of the business. This may include a review of the company's income, expenses, assets, liabilities, and cash flow.
Legal matters: The buyer will review any legal documents related to the business, including contracts, leases, patents, and trademarks. They may also review any litigation or regulatory matters that could impact on the business.
Operations: The buyer will review the operations of the business to understand how it is run and to identify any potential issues or opportunities for improvement. This may include a review of the company's products, services, customers, suppliers, and competitors.
Human resources: The buyer will review the company's human resources practices, including employee contracts, policies, and benefits. They may also review employee data, such as headcount and turnover.
How to prepare for due diligence
There are several steps you can take to prepare for the due diligence process:
Gather necessary documents: It is important to have all relevant documents organized and readily available for review. This may include financial statements, tax returns, contracts, and legal documents. (Many of these documents should already be in a data room that was built out before going out to market. We will go into what is in a data room in future newsletters so make sure you subscribe so you do not miss anything.)
Identify potential issues: Try to anticipate any potential issues or concerns that the buyer may have and be prepared to address them. This may include identifying any potential liabilities or risk factors that could impact the value of the business.
Be transparent: It is important to be transparent and honest during the due diligence process. If there are any issues or concerns, it is better to bring them to the buyer's attention upfront rather than trying to hide them. If you do not disclose them early on, you might lose the trust of the buyer which could derail the deal. If the deal does close and things are not discovered or disclosed, you might be liable and the repercussions could be a lot worse than anyone could imagine!)
Seek advice: Consider working with an investment banker or other professional to help you navigate the due diligence process. They would be able to provide a level of experience, having gone through the process with others, and know what to expect, where lines could be drawn, what are realistic expectations, areas to negotiate, things to push back on, or give an industry suitable response. (A bonus is, the investment banker might be seen as the bad person in the deal so the goodwill can remain strong with the seller and buyer. This allows a strong post-closing relation between the two parties who might be in a relationship for years to come)
Depending on the deal the due diligence could take months and at any time the buyer might decide not to move forward. Even after being involved for months, don’t lose track of your roles in operating the business; hit the projected milestones because if targets are not met the buyer might ask for price adjustments. Not because of things found while doing due diligence, but because during this exhaustive process the owner got distracted from running the business and numbers slipped. (Yes, I have talked to people who have actually admitted they dragged out due diligence in hopes that they would get a better deal)
What happens after due diligence? Once the due diligence process is complete, the buyer will typically provide a report outlining any issues or concerns that were identified. If the parties are able to reach an agreement, they will move forward with the transaction. If the buyer is not satisfied with the results of the due diligence process, they may decide to terminate the deal.
Overall, the due diligence process is an important part of the M&A process and can have a significant impact on the success of a deal. As a seller, it is important to understand what to expect and to be prepared for the process. By gathering necessary documents, identifying areas of concern and preparing a data room, you can save a lot of headaches and not waste time when you enter the dentist’s chair.
*** The content is not intended to provide legal, financial or M&A advice. It is for information purposes only, and any links provided are for your convenience. Please seek the services of an M&A professional(s) before entering into any M&A transaction. ***
For More Information
Shawn Flynn is a Principal at Global Capital Markets, a premier middle-market investment bank with a global presence. Shawn has expertise in mergers and acquisitions, capital markets, financial restructuring, and secondaries. He speaks Mandarin and is the host of the award-winning Podcast The Silicon Valley Podcast. Connect with him on LinkedIn.
Shawn Flynn, Principal SF@GlobalCapitalMarkets.com
Tel (415) 578-1445 Ext. 4
About Global Capital
As a middle market investment banking boutique, Global Capital provides mergers and acquisition advisory services, access to corporate debt and equity capital, and strategic advisory services to successful middle market companies. For over twenty five years, our team has offered companies a unique blend of sophisticated financial expertise and access to the global marketplace of buyers, sellers and financiers.
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