If acquiring a business feels a little like buying a rather expensive used car, then the due diligence process is your best chance to ‘kick the tires’.
Due diligence – whereby you closely examine the business’s physical and non-physical assets, including premises, employees and books and records – gives you a chance to see if the seller’s claims about the business stand up to scrutiny.
It means the buyer can get to know their target business and uncover serious shortcomings before they commit to paying an inflated price.
Sellers, meanwhile, must understand how the process works, make sure that the business is as ready as possible for what is usually a detailed inspection, and furnish the buyer with the information they need without unreasonable delay.
Let’s consider what the process of due diligence involves and – whether you’re a buyer or seller – how to keep the deal on track on terms favourable to you.
Due diligence usually begins after you have agreed a deal in principle with the seller, but before signing a binding contract.
Assuming the owner of your target business has an advisor to manage the transaction, you should address your enquiries to that person. Be aware also that the advisor’s brief will include establishing your credibility.
It’s wise at the outset to engage your own professional advisors – business brokers, accountants or solicitors – with experience of selling businesses to give you advice on steps to take and for a second opinion.
Reasons for selling
Early on you should also find out why the vendor wishes to sell up and what they hope to gain from the transaction.
Most sellers will, naturally, wish to make as much money from the deal as possible. But for some sellers, this goal also competes with a desire to find a buyer they trust to protect their legacy.
In the latter instance, they may be willing – keen, even – to stay on in the business for a period post-sale. This would usually be in an advisory/consultative capacity, without remuneration, for a pre-agreed fixed period.
Do your own homework
Your task now is to thoroughly assess the business’s physical assets, like premises and equipment, its employees and relevant paperwork.
You should arrange to visit the premises for preliminary discussions with the seller, to check the condition of the physical assets, as well as getting a feel for the atmosphere and workplace culture.
Request from the buyer copies of trading accounts, customer contracts, employee contracts, documentation about pension arrangements and so forth.
Some questions concerning transfer of ownership and consent can be tricky to resolve. These include intellectual property rights, assets shared with third parties (for example IT facilities), transfer of sales and supply contracts, and licensing approvals granted by third-party authorities.
Seek to ascertain which managers and employees are most fundamental to the business’s success. Ideally, you should then try to establish if they are willing to stay in their positions beyond the transfer of ownership.
Should the business depend to a worrying degree on the owner’s input, then you may request that they too stay on for a period post-sale. Are they hands-on owners? Is their knowledge and rapport with customers pivotal to winning and retaining customers?
You and your advisors must negotiate the terms of such an agreement, particularly the duration of their role and its scope.
Keep all options on the table – including the nuclear option
Ultimately, you agreed a price before due diligence on the understanding that everything the seller told you about the business is true and accurate and that important information has not been omitted.
Should due diligence uncover any problems obscured by the buyer, you should consider revising the price downwards. If the seller refuses, or if the problem is serious or raises doubts about the seller’s honesty, it may be wise to walk away altogether.
You should always be prepared to walk away – otherwise you have no leverage.
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If you are to win the buyer’s trust then you must be willing to share sensitive commercial information about every aspect of the business. Before doing so, therefore, you must request that the buyer signs a non-disclosure agreement.
Pre-sale due diligence
You may wish to conduct your own, pre-sale due diligence to remedy any problems before you put the business on the market. Like rehearsals for a stage production, this ‘mock’ process is all about identifying and addressing weaknesses before they can do any real damage.
Make sure you have a competent, reliable advisor, or team of advisors, with experience in business sales. Besides conducting these due diligence trials, independent professionals can help you write a sales prospectus, formulate deal structure options to smooth and accelerate negotiations, and vet serious potential purchasers.
They can also formulate buyer confidentiality agreements and phase the release of sensitive information at appropriate junctures. In addition, your experts might suggest strategies to minimise the risk of any pending business transfer leaking out and creating unwanted adverse publicity.
Be prepared for the process to be lengthy and be thorough in addressing problems, ideally before the buyer spots them.
Identify the managers and other key employees who can help you avail the buyer of the information they need to know. Warn these employees in good time of what is expected of them. Encourage them to get documentation and information in order and to rectify any problems that buyers might notice.
Above all, prepare the business and your employees for the due diligence process with these questions in mind: If I were the buyer, what questions would I ask? And which parts of the business would I be examining most closely?
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