Due Diligence, the deep business review that every selling process must go through. It is how buyers calm their uncertainties about the deal and gives them the confidence to write the closing check. As a seller, you may see this process as exhausting and intrusive, but if you think about buying a vintage car (perhaps a 40’s Ford Pickup or maybe to round out your Testarossa collection) you would want to look under the hood.
You’d want all pertinent information up front and your answers to your questions to be supported by documents. You believe that there has been only one owner and that all the parts are original, but there is doubt until you see proof. You want to make sure this special car is truly special.
Business owners, if you want maximum value and a smooth transaction for your truly special business, you need to be prepared and patient. Here is a quick comparison of the due diligence for buying a business to the due diligence for buying a vintage car.
When buying a car, the more you understand about the pedigree, mileage, and ownership history; the easier it is to know what to expect from the vehicle. A business buyer will want to know where this business has been so they can project where it can go. They don’t get a test drive so this is upfront in order to ensure a smooth ride down the line.
Financials will be top of mind. The buyer will start with costs, margins, cash flow, debts, securities issuances, and loan agreements, though the emphasis will vary depending on the business.
Inspecting the Exterior & Interior
If you expect a premium for your ’69 Dodge Charger, it will need a flawless exterior and appropriately worn interior. If you want full sticker price for your business, expect the buyer to examine the tangibles of your company closely.
A buyer will look at the condition and organization of your equipment, inventory and work space as more than a predictor of near term costs. They will also look at how the seller takes care of the visible assets as an indicator of how they take care of the things that cannot be seen, such as customer relationships and employee morale.
Clean, well maintained equipment and organized inventory gives the buyer comfort that customers and employees are served.
IP, trademarks, permits or any other official certification will need to be verified. Purchase orders and continuing contracts all affect the bottom line.They will also need to be confirmed.
Under the Hood
After the auto passes the eye test, it’s time to inspect what makes it hum. Lifting up the hood of your business can be stressful. What makes your business run is sensitive information and should be presented carefully but also transparently.
Who a buyer will work with is important and they will want to know about the employees, share holders, contractors and/or vendors. The buyer will want to know everything from their backgrounds, to your relationship with each, to your organizational structure.
Customer information and the marketing that brought them to the table will come up. Buyers like to see recurring and diversified customer relationships. The advertising tactics and costs that produce those customers are important to examine. The balance between transparency and IP protection is a delicate process that is handled differently in each deal.
Again, there are no test drives. A serious buyer will be thorough with this disclosed information.
Have a Mechanic Inspect It
Most business buyers will have professional help (lawyers, researchers, financial fairies) to help them through due diligence. That’s why a business seller will need to team up with a legal team to protect their post-transaction exposure and an advisory team to oversee the process. Due diligence can spiral out of control without the right guidance to ease tensions, smooth discourse and manage expectations. A good business broker will be able to wipe away any battery rust as to not distracted from the V8.
Important to note, this comparison is to help you understand this process. There are many more legal ramifications in the due diligence of buying business vs the due diligence of buying a ’58 Corvette.
IBEX Side Story
“I was once working on a due diligence project on a $135M deal. My client was buying a division of a publicly traded company with operations in the U.S. and in Canada. My client’s CEO visit to their Canadian operations revealed some experimental practices not approved in the states. The seller kept telling us that it was no problem and that they were expecting Canadian approval in no time. After digging a little deeper we discovered that they had been pursuing Canadian approval for over five years. The seller then told us their customers knew the risks and their contracts put the clean-up cost on the customer if Canada denied their request. Well the customers who had agreed to the clean-up cost turned out to be the five largest customers of the company we were acquiring who made up of 60% of the divisions revenue. We then dug in to obtain an estimate of the clean-up cost: $100M per site. So my client was buying into company that might need to ask its five top customers to spend $500M to resolve an issue created before we bought the company. The deal never closed. The sellers were being truthful and the attorneys could have resolved this issue in the purchase agreement, but due diligence protected my client from a $500M risk. Remember the whole cashflow evaporation concern?”
Chuck Harvey, is the owner of International Business Exchange, Inc., one of the oldest, largest and most respected M&A Advisories in the profession. Prior to IBEX served as CEO, COO and CFO’s of Fortune 500 Companies, thriving middle market companies and start-ups. His extensive financial experience with the public market, private equity and venture capitalists includes more than three dozen buy-side and sell-side transactions on three continents. He is also the found of Infusiac, LLC and The One 21, LLC.