In 2012 I became solely responsible for taking my company through the Due Diligence process, this was after an approach from Private Equity to purchase our company.
I felt a huge responsibility, I was one of 3 directors with equal shareholding. My buyer wanted a quick sale, I was assured the process would take less than a month and would be light. We concluded the sale almost 6 months later after an exhausting and at times, an almost humiliating process. I was lead to believe after the process that the buyers team had been fairly easy on us. Having now taken several companies through the process, I look back and wish I knew then what I know now. Here is a quick guide on how to survive the part of selling that most sellers fear most.
What is due diligence?
If you are looking at selling your company, no matter how big or small you will most definitely run into some form of Due Diligence. Even if you are selling to friends or family they are going to want to know everything there is to know about the business they are buying.
When I talk to clients about Due Diligence the response I often get is hostile, fearful or indifferent. The response is usually down to a lack of understanding or familiarity with the process and what DD actually means. In this short piece, I’ll try to clarify the process and the reasons behind why it exists. I will also give an overview of the process and a bunch of tips I have gathered through personal experience on how to successfully navigate a DD.
DD is a part of the larger process of the ’M&A (merger and acquisition)‘, typically DD is entered into when one party wishes to acquire all or part of another, either as part of an investment or to achieve some other strategic goal. DD signifies intent, usually on the part of the purchasing party.
The ‘seller’ or ‘target’ (the party that is either selling their stock, emitting new stock or selling some assets – I am not a fan of the phrase “Target”) and the ‘buyer’ (or ‘acquirer’) have agreed on the basics of a deal to be made. By the point you get to DD, what is being sold by who to who has been agreed. A valuation has been agreed upon and everybody understands the terms of the deal.
The seller has by this point informed the buyer about anything that is material to the deal and has done so in writing.
It is now down to the buyer to ascertain that the seller has indeed disclosed everything that is important or material to the deal. The DD process also protects the seller, as in almost every case, the seller may not always be aware of everything they should have disclosed (possibly by negligence or simply a lack of experience in the process). Sellers are also people, therefore they are not equal in their ability of willingness to fully disclose everything. Buyers also have an obligation to research the object of their interest (for liability reasons should an issue arise later down the line) to make sure that if there is a problem afterward the sale that they can demonstrate that they have done their best to ascertain the position of the target at the time of sale. Again, a good DD process will protect the seller by allowing them to demonstrate they have provided all information required by the buyer, protecting the seller against any warranty claim that may arise in the future.
So due diligence is all about ensuring that the risk to both parties has been assessed and verified to be as accurate as possible. So, if you want to successfully get through a due diligence process (with agreement largely in tact) then you will need to have laid the foundation for DD way before the process starts. At Epsilon, we start the process of DD almost as our first action.
Surprise! is not good during DD. In almost every case, a surprise will affect the seller more than the buyer. I have seen many deals fall off the rails when that skeleton in the cupboard emerges to the dislike of the buyer. Selling a company is largely about trust, when there are substantial changes to earlier statements, these changes will inevitably raise further and more probing questions in DD.
The best advice I received from my Solicitors during my personal DD processes, “treat DD as a friend, tell them everything”. By doing so, if something comes out in the wash post sale then you are protected. If you have hidden or failed to disclose a material (or sometimes fairly immaterial point) then that could cause problems for you in the future. If you have fully disclosed, then in most cases you are warranted by your disclosure.
It is generally understood that both parties bear their own costs and financial burdens of DD until the final contracts are signed. If you get into the due diligence phase but the deal does not go through that unfortunately reflects badly on the seller (not in every case is failure to make it through DD the sellers fault) other potential buyers will assume that indifferences came to light during the due diligence and these discrepancies caused the deal to collapse. For this reason, my tip is to keep the negotiations with potential acquirers very quiet indeed.
DD is painful, there is no point disguising that fact, however it is also an opportunity to learn a lot about how your company is viewed by an outsider. An outsider’s perspective alone is worth a lot and will help you to gain an insightful that can be used to improve or manage the business in a way that suits a purchase better.
Due diligence can take anywhere from a few days to 2 months. The length of time is a reflection on how complex the business is and the value placed on the sale. DO NOT go into a due diligence process unless you are sure that the other party has every intention of completing the deal and that you have completed a separate DD on the purchaser ensuring they have the capability of completing the deal on the table.
DO NOT start any process that looks like DD until a terms sheet has been agreed upon and signed. All parties, including all external parties completing the DD process (and there is likely to be many including; independent HR, Financial Auditors, Solicitors, Advisors and Industry Experts) have been signed a comprehensive and solid, binding NDA. Remember, if you have negotiated hard to get the deal you want, it is very likely that the objective of the DD process (on the buyers side) will be to bring the price back to what the buyer wants it to be. Don’t let that happen by going into DD unprepared (we most certainly won’t let that happen).
The detailed process
You will be visited and interviewed by experts across a broad spectrum of disciplines. Industry experts may also be called upon to verify the claims. Technology and Software companies are often subject to greater levels of scrutiny as the value is often within Intellectual Property or a software or process unique to that company.
Due diligence can become confrontational, especially when there is a level of conflict. Confrontation usually does not benefit the seller. We manage conflict as our upmost priority and will act as “Bad Cop” to protect future relationships, particularly if there is going to be some sort of working relationship moving forward.
Fortunately, by the time the process of DD has started, most conflicts have been ironed out therefore these cases are pretty rare. The important thing to remember is that the people, companies and advisors doing due diligence are not your enemy – This was a point I have had to remind myself of several times over the past years. I will also remind the people conducting the DD process that they also don’t need to behave like the enemy. Their job is to verify that the information that you supplied is accurate and that there is no more information that is of importance. I will say it again, preparation is absolutely key here!
Transparency is the only way to build trust and trust needs to be established to ensure the transaction can be completed by the people in the process.
The format of DD will differ from company to company, however most VC’s or buyers will have a team that they use for all purchases. In most cases, the broker (Epsilon) will know the process as the VC is known to them or will ask the difficult questions on your behalf.
Over the first 2 weeks, there will be a lot of people calling to introduce themselves and how they fit into the process. Normally, the first introduction will go through us as the broker, ensuring you are not caught unaware by an unexpected phone call or email. It is important that the process is tightly managed and all parties conduct themselves in the best interest of the sale.
Any recommendations, changes or alterations to the original deal will be discussed after the presentation of a report from the buying party. In virtually all cases, something will come up that will affect the original deal. These are not always to the detriment of the seller and may only result in very minor penalties being imposed. How these changes are handled and negotiated will determine if there is a financial loss to the seller.
My final few tips
If you have planned properly success in the DD stage is actually very simple;
Appoint a single point of contact and ensure that the contact has the assistance of all the other interested parties. Make sure that contact knows the business very well and is credible.
Make bad news, good news. “It is good news that you have come forward and told us about the bad news before we started the DD process”. A good buyer will thank you for being upfront.
Three words: Honesty, Truth and Respect.
It is what it is ! – My most favorite of sayings. Do not fall into the trap of over selling the company, any discrepancies will be highlighted in the process.
Communicate clearly internally. An insignificant point of detail may affect the answer of a colleague. If you are not sure, take a step back, ask then communicate. Never communicate anything unless it is true and agreed.
I hope that this piece (which turned out to be longer than I expected) is helpful.
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