Mergers, Acquisitions: Four Secrets to Due Diligence Success
When a seller tries to hide facts, or doesn’t disclose them to buyers and they are uncovered during due diligence, say goodbye to the deal.
According to Forbes, “approximately half of all deals fall apart during the formal due diligence stage, and one of the most common reasons this happens is due to the buyers uncovering issues which the sellers didn’t disclose earlier.”
These situations are never pretty. Accusations are made, lawsuits follow, buyers lose their investments, sellers forfeit any earn-outs and face “financial claw backs” and businesses deteriorates rapidly. Nobody wins. These situations are all too common and in most cases should never happen.
Think about it. You spend years building a successful business. You decide to sell, spend time trying to find a qualified buyer to sign an LOI (letter of intent to purchase your company) and begin negotiations, only to have your potential deal fall apart because of undisclosed items arising during the due diligence process.
Four Secrets to Due Diligence Success
So what can you do about it? Below are four “musts” for successful deal making.
First, don’t rush to go to market. Rushing to market can be caused by age, illness, burnout, divorce, legal problems, partner squabbles and myriad other reasons. But, in spite of these reasons, rushing to market could significantly impact your ability to get an optimal deal for your company. Going to market unprepared is a recipe for disaster. Since most business owners will only sell a company once in their lives, it’s a good idea to engage a professional M&A adviser to help prepare for the transaction process in general and the due diligence process in particular.
Second, prepare for the buyers’ due diligence process. Prepare for intense buyer scrutiny. Far too often business owners simply do not do their homework prior to the process and pay the price in the end when their deal falls apart. If a seller is not prepared in advance, due diligence can drag on for weeks; and, often, if it does, buyers get cold feet and move on to other, more attractive opportunities. Have an adviser create a typical due diligence check list and put you through the rigor of answering questions that could arise.
Third, disclose, disclose, disclose. Throughout the discussions, negotiations and the due diligence review between a buyer and seller, credibility is being tested. In your discussions with the buyer, explain your challenges before they find them; understanding them will allow the buyer to get comfortable with your business. Disclosing the challenges actually builds trust and credibility. As long as the parties deal honestly with each other, trust builds. But, if either side tries to hide material information that surfaces during due diligence, trust will be shattered. The cardinal rule of deal making, during the due diligence process, is disclose all material information.
For example, in a transaction involving a moving and storage company, a large percentage of the company’s revenue came from a single government contract. The buyer wanted to read the master contract between the company and the government agency to be sure it was transferrable as the seller had represented. However, the seller knew it was not really transferable and would have to be reviewed by the government agency because of change of ownership. He figured he could convince the buyer to buy the company’s stock instead of the company’s assets after the buyer was emotionally invested in getting the deal done. Wrong strategy. The buyer agreed to complete all other components of due diligence and would review the contract afterwards. Sure enough, the buyer discovered that the contract was not transferable and could only continue with an entirely different deal structure complicated by tax issues and potential liabilities. The buyer felt mislead and the deal disintegrated.
Remember, the goal is to sell the business. Disclosing the good and the bad about the business, warts and all, is just prudent deal making.
Fourth, think like a buyer. Look at your business as if you were a buyer. Ask yourself, what would I need to know about this company if I were buying it? What are its strengths and weaknesses?
A great exercise for sellers is to put together a list of everything that worries them about their own business – those that keep them up at night. Then, detail potential solutions to each problem that can mitigate a buyer’s concern. For example, if the business has some old equipment, the seller can be proactive and have a spreadsheet ready that details replacement costs and financing options along with the potential improved efficiencies that will contribute to the bottom line.
Despite the dismal statistics of failed deals, transparency between the parties is the key to success. When a buyer wants to buy and a seller wants to sell, and the parties like and trust each other, they will find a way to get the deal done.