Many readers will be very experienced in the subject of Due Diligence (“DD”) but this series of articles is derived from a presentation given at the Business Show at ExCel in November 2018 and is geared towards the SME business owner looking to sell their business who has had little experience of the DD process.
This is the first in a series of three articles in relation to the DD process.
From a Sellers perspective much of what happens during the DD process is defensive and responds to issues raised by the Buyer, but there is a very important reason that you want to handle the DD as positively and proactively as possible. That is that the more that you can satisfy the Buyer as to how good your business is, and that means not just from a financial perspective, but from a “how strong’s the house built” perspective, the more comfortable they will be about buying it and value it for its inherent strengths.
Also, if, as Seller, you are able to cover off some of the sensitive / judgemental areas of your business as part of the DD, the less you will be asked to provide warranties and indemnities. You want to try to openly disclose as many of these issues as possible so that you get the Buyer to make their own assessment of the items and not look to you to effectively under-write them as part of the sale.
As a Seller you’ve taken the decision to sell, you’ve agreed a deal with a Buyer and signed the heads of terms …. now it just needs the formality of producing the final contract to sign and the deal is done, but there’s this thing called due diligence that needs to take place; surely that’s not going to be a problem at all … or is it?
Unfortunately, many deals can and do fall over at this stage or the deal gets significantly changed and the Seller can get very disappointed, but may end up with the attitude, “I’ve got this far I just want to get the deal done now” and it becomes much less beneficial than it started out.
What is Due diligence? In the context of a business sale it is a set of checks that are meant to satisfy the prospective Buyer that what they’ve been told about the business is accurate and true.
Nothing wrong with that we’d all agree, after all we don’t buy anything ourselves until we’re satisfied that what we’re buying is what we expect, particularly if it’s a large purchase, like buying a house for example. We would not buy a house without getting specialist help and support. This would generally include a survey and legal advice about the house sale. We all generally understand that the lawyers do things like searches etc. and the Seller has to produce a list of everything included in the sale and we know the Sellers are supposed to detail anything that’s wrong, or any disputes they have with the neighbours, or around planning permission etc. No doubt you’ve had to do this when you’ve sold a house, and yes whilst it’s a little time-consuming and costs a bit for the lawyers, it’s not that bad is it?
But translate this into a business sale:
You’re not generally selling a property so there’s no bricks and mortar and even if you are it normally only forms a small part of the overall sale price.
You’re not able to sell “certainty” of cash profits from the business and you’re certainly not selling past profits of the business.
What you are selling is the anticipation of the business producing cash profits into the future and the Buyer needs to try to satisfy themselves that these cash profits will be produced, as has been suggested they will be.
You are also selling something that’s been trading for maybe a good number of years and as is generally the case it will be a share sale and ownership of the company will be “warts and all”. Buyers do not know what these warts may be and unless you tell them they probably won’t find out, certainly not without doing the DD. If problems only come out after the sale the Seller may be liable for some financial penalty.
So how do they satisfy themselves, they can only reasonably do this by undertaking a variety of DD checks.
Depending upon the type of sale transaction, the due diligence and legal stages can take as little as 6 weeks but they often extend to 3 months or more during which:
- Solicitors for both parties deal with the Buyer's due diligence checks and prepare agreed legal documentation;
- Accountants for both parties liaise to deal with the Buyer's financial due diligence enquiries;
- Buyers (and/or) their advisers make enquiries into commercial aspects such as key customer relationships, senior employees etc.;
- Buyer and Seller jointly prepare for a smooth transfer of ownership.
There are three main aspects of the DD process:
- Financial: this will be an analysis and review of your company’s financial accounts, corporation tax returns, VAT returns, accounting policies and general financial trends.
- Legal: this is a thorough inspection of your company documents; its statutory books, contracts and agreements; any ongoing, pending and potential litigation; environmental factors; and legal and regulatory compliance.
- Commercial: this typically breaks down into three areas:
- Business: this is the analysis and review of your current business plans, customers and products and markets and competition.
- Operations: this is the analysis and review of the company’s operating processes, its technology, fixed assets and facilities, as well as premises and insurance coverage.
- Human Resources: this looks at the company structure, employee remuneration and benefits, management and personnel, and general HR matters. For example, are there any staff disciplinary issues, or union disputes?
Now here's the government health warning.
As a Seller:
You will not enjoy this part of the process one little bit
You will find much of the questioning tedious and time-consuming
You will say "why are you asking me this again, we've already discussed this point"
You will think "why can’t they get this themselves, we've filed all of our accounts and returns at Companies House"
You will take some of the questions raised as very personal attacks on you and your business
You will get frustrated with more questions coming back after you've answered the first ones
This will take up a lot of your personal and your management teams' time
If you haven't told your staff what's happening, you will find there will be lots of questions as to why you need such and such pieces of information
This stage of the selling process is always difficult for Sellers
However, as with most things, preparation and planning helps greatly
Most of the DD requirements are not rocket science
Your professional advisers should be able to tell you in advance most of what will be asked for
Start getting it all together early, the more you can do, ahead of the actual DD requests coming through to you, the easier it becomes
Set up your own data room - this will generally be just a part of your system that you can confidentially copy various documents into
Keep the data room well structured so that the documents go into sensible places
Get your professional advisers to help you set up the structure and then designate specific areas to those people in your team who are involved in this process
Don't just do this yourself, you've appointed trusted professional advisers, get them to do as much as possible
They won't take it as personally as you will and they've done this many more times than you have
Expect to get irritated by it but remember why you're doing this
In the next article we’ll look at how best to try to manage during the DD process.