When purchasing a business the due diligence stage allows the buyer to verify information pertaining to the business in order to determine whether to proceed with the purchase. The due diligence period also permits the buyer to determine if there are any barriers or risks associated with the transaction. Accordingly, the transaction closing is usually conditioned upon the due diligence stage being completed successfully.
While there are many operational, legal and financial components of due diligence, some less talked about ones are: the seller’s due diligence of the buyer, the buyer’s due diligence of the seller, including the reason for sale.
Some M&A advisors claim the reason for sale is immaterial-my colleague recently saw a sale listing citing ‘their mother’s ailing health’ as a reason for sale. He quipped that the reason for sale didn’t need to be examined as much as that the business needed to be analyzed. Was the multiple justified? Was it a good fit for the buyer? But just like anything else for sale, if the business is so good or profitable, why doesn’t the seller just keep it? Are they retiring? Could they gift it to a relative, if there is someone in their family who would be a good operator?
It may be good for a buyer to understand who the seller is. What is their background? Have they operated or sold other businesses successfully? What has happened with the other sales-were the new owners able to get a good deal? Is the seller a serial entrepreneur or can they not execute? Did the numbers add up? Did the financial projections/trends continue or was there some element of exaggeration or fraud? Some businesses are dependent on the seller’s special skill or knowledge. In the hands of a new buyer they may not be as successful. Then the buyer has wasted his money.
Most due diligence investigations are performed by the buyer, but in certain circumstances the seller will also conduct searches and other due diligence on the buyer. For instance, if there will be seller financing or seller will be receiving shares as part of the purchase price the seller may wish to conduct their own due diligence. Whatever consideration isn’t received at closing is worth less-like the old saying ‘a bird in hand is worth two in the bush’.
The due diligence stage also provides the buyer with information to assist with the negotiation of the main agreement. The results of the due diligence may cause the buyer to request that specific representations and warranties be set out in the definitive agreement, or that certain additional indemnities be given by the seller, or even that the purchase price be adjusted.
If you are purchasing a business, it critical to ensure that the due diligence associated with the purchase is conducted in a complete and thorough manner. The due diligence stage, if conducted properly, should provide the buyer with a complete understanding of what he or she is buying and an analysis of any risks associated with what is being purchased, so that the transaction may be completed without any unpleasant surprises.
Exit Strategies values control and minority ownership interests of private businesses for tax, financial reporting, ownership transfer, strategic and other purposes. If you’d like help in this regard or have any related questions, you can reach Bob Bates, CPA, CVA, CFE at (415) 793-7777 or firstname.lastname@example.org.