Thought Leadership

There is no single process that everybody follows when purchasing a business, and there are many factors that determine whether a business, once bought, will fulfill its desired purpose. But if there is one thing that will mitigate the chances of failure, and increase the chances of success, it is conducting detailed due diligence on the company you intend to buy – before making the purchase permanent and irreversible.

In the early stages of a transaction, buyers and sellers rightly focus on the financial terms of a transaction, with the key element being the valuation of the seller’s business. Once this is agreed, it is often customary for both parties to sign a Letter of Intent (“LOI”). Although the LOI is primarily non-binding and contains purchase price, method of payment etc., it typically also includes an exclusivity period during which the seller agrees to not talk to any alternative buyers – often referred to as the ‘no-shop’ provision. The rationale for this exclusivity period is that time and money will now be spent on (a) the buyer conducting due diligence on the target business, and (b) legal counsel for one party drafting the legal documents that are required to close the transaction.

But what exactly is due diligence, and why it is such a crucial part of a successful transaction and a subsequent productive operation?

The main purpose of due diligence is to test the veracity of the information received from the seller and its representatives, regarding the financial, operational and legal status of the business. In addition, due diligence presents an opportunity to dig deeper into certain topics – to get beyond the ‘spin’ of the sellers initial set of documentation.

Operational Due Diligence

A business’s financial performance is not the only aspect of the business that needs to be tested. What is the quality and sustainably of its customers? Does the seller have the right personnel in terms of skills and experience? Is management available to run the operation post-transaction? How much has the company invested in sales and marketing? Do you have a full listing of products and services? Pricelists? How much information do you have about the competitive landscape?

We recommend visiting the seller’s premises and talking to managers, executives, and employees. Examine the org chart and ask questions. Ask for short resumes of the key managers. If applicable, check out the factory floor – what is the state of equipment and infrastructure? A seller that has put off necessary repairs and maintenance is not being frank about the cost of operations. Also crucial is the company’s IT infrastructure and maintenance.

Again, if you don’t have skill-set internally, hire an M&A advisor. The money spent will be worth the assurance that you are buying an effective and sustainable business.

Document Management

Virtually all the documents that you will be reviewing will be confidential in nature. You will need to return or destroy these documents if the transaction does not close. We recommend a virtual “deal room” is used to store and upload/download documents. That way there is a clear audit trail of who has uploaded, reviewed and downloaded documents. This will provide legal assurances to both buyer and seller.

Be diligent, hire experienced professionals, and good luck with your transaction! Please feel free to contact uswith any questions you may have on due diligence. We’ll be happy to assist.

Author: Paren Knadijian