The Experience of “Due Diligence”
or, Where “The Rubber Finally Meets the Road”
One day, after undergoing several weeks of an exhausting company examination, one of my clients (a business owner), frustrated from the seemingly endless buyer information requests, turned toward’s me and characterized the Due Diligence process as – one of the “worst experiences of my life”.
Often, at the moment you begin this due diligence journey, there is someone mysteriously in the background who anxiously whispers…”gird your loins”!
Be prepared for what is to come.
Due Diligence is the process where the buyer confirms the “facts” of the company as presented by the seller and his representatives. It is time consuming, psychologically and emotionally draining for an owner and often the point in the transaction cycle where most acquisitions collapse. This is where the rubber finally meets the road.
What once was an acceptable offer – suddenly dissipates and an enthusiastic buyer drifts into doubt or “buyer’s remorse”. The seller becomes irritated over “unreasonable” requests for additional details and documentation. Buyers become suspicious over delayed or incomplete data. Then suddenly new actors emerge from all directions, bankers, attorneys, business advisors, accountants…
Tensions and emotions run high from a Seller who is witnessing his lifelong accomplishment end –
and a Buyer who is risking everything he has assembled – attempting to begin.
The Due Diligence Process:
It is the stage of the Transaction Lifecycle where the buyer will investigate and clear the contingencies incorporated in the “Final Agreement to Purchase” and prepare for the closing of the transaction. It may only consume a matter of weeks or endure for months. Just prepare yourself for the experiences to come, bring your patience – and things will work themselves out.
A Couple of Ground Rules:
- Maintain confidentiality with employees, customers, vendors and other business stakeholders. Why? Maintaining confidentiality keeps the business healthy, allows for employee retention and prevents your clients from raising questions with competitors and/or the market in general.
- In addition, prepare to;
Have all the necessary information already assembled and easily accessible. This will save you time, endless aggravation and preserve your sanity… and oh yes, have available every ounce of patience you can muster.
It’s helpful to create an internet accessible “data room” so all documents, exhibits and financials can be posted for all participants to view 24/7.
Due Diligence Basic Information Requests:
This is when the buyer verifies information provided by the seller ( Seller’s Discretionary Cash Flow being the most important ) which was used as a basis for the offering price, transaction terms and conditions.
Information Requests Usually Include:
- Tax Returns (last three to five years)
- Sign form 4506t (Tax Transit Request)
- Financial Statements: Last 3-5 years P & L’s (Income Statements), Balance Sheets and list of owner add-backs (owner’s salary, benefits, bonuses, distributions, plus and other financial benefits paid for by the company, it also will include company income taxes, interest expenses and non-cash expenses such as depreciation or amortization).
In addition you will need to present:
- Itemized Patents, Trademarks, Copyrights, Proprietary Information
- Asset Lists
- Inventory Catalog with Aging
- Roster/History of Customers, their % contribution to total sales, any specific contracts or agreements with clients.
- List of Key Employees, their Contracts and/or Incentive Programs (for a buyer, this is often one of the more important requests)
Your attorney or the Buyer’s attorney will prepare closing documents that may include:
- Definitive Purchase Agreement
- Bill of Sale
- Promissory Notes
- Security Agreement
- Consulting Agreement
- UCC Searches
- Bulk Sales Notice
- IDES Filing
- Corporate Resolutions for Buyer and/or Seller
- Closing Statement
Possible Post Closing Filings:
- Amendments to Articles of Incorporation or Articles of Organization
- Assumed Name Filings
- UCC-1 Filings
As you can see there are innumerable steps, procedures and responsibilities during the closing process. That’s why it is so important that intermediaries, attorneys and business advisors, from both the buy and sell sides, are consulted each and every step of the way.
The business broker, as quarterback, helps facilitate the process by maintaining a transaction cadence (if and when necessary) among all participants. It’s helpful to have a series of “sign-offs” for the buyer and seller’s representatives to document as each contingency is assessed and completed to their satisfaction. Oftentimes one of the transaction’s attorneys, accountants, or business broker, establishes a “virtual data room” or “VDR” for the safe exchange of confidential information. The intermediary should encourage everyone to follow a mutually agreed timeline, while providing guidance and support for the seller up to the closing table and a successful divestiture.
Even with all of the above prescribed chaos, yes, these deals do get done – successfully! Just focus on one step at a time… and bring your patience.