“If we are able to conduct such a due diligence review, we believe that we may be in a position to make an offer for the entire company at a substantially increased price” Carl Icahn

Due diligence is the act of investigating or confirming that all of a buyer’s assumptions about how a particular business has performed in the past is more or less true.

Organized companies can drive value for themselves by providing well prepared and accurate information to buyers in a timely fashion (hours not days).  This allows all participants in the initial review of a business to proceed at a quick pace (important both if it’s a broad auction process and also for maintaining deal momentum) and allows everyone the chance to move quickly to help separate those who are truly serious from tire kickers.

We always advise our clients at the outset that the goal of any process is to close a transaction as fast as possible to reduce the amount of business and market risk.  If properly organized, due diligence and definitive documentation can be completed in 60 days.   Poorly organized sellers and buyers who sense no need to rush can push the process out to 6+ months.

Due diligence is typically completed in two stages.  Initial due diligence is a high level overview of the business, its operations, the company’s assets, growth prospects, clients, employees, and the seller’s motivation for selling.   Information regarding the company is provided following the potential buyer signing a “CA” or confidentiality agreement (sometimes also referred to as an NDA or Non-disclosure Agreement).  This initial diligence information is often presented within a management presentation and/or a confidential information memorandum and these documents provide a summary of all of the key information for easy review from prospective buyers.  Additional information provided include reviewed financials, asset list, employee list, monthly financials in excel format, customer list (revenue by client if not a direct competitor), critical contracts, HS&E records and a financial forecast.  This data package should be comprehensive enough that a prospective buyer can submit a non-binding Letter of Intent (“LOI”[1]) that would highlight the value and broader offer for the business.

We will cover off what’s typical in an LOI in a future posting, but assuming that both parties agree on the broad strokes of a deal, then advisors will start to draft and negotiate the definitive documentation[2] and buyers will simultaneously complete their confirmatory due diligence.

Confirmatory due diligence is exactly as its described.  It’s the act of confirming all of the previously provided information is correct (which was the basis of a buyers initial proposal).   Buyers will usually request an audit or quality of earnings report which is completed by a third party accounting firm, environmental due diligence, equipment appraisals, review of material operating agreements, banking agreements, real estate and lease agreements, intellectual property, government authorizations and permits, insurance, legal review (lawsuits, proceedings by employees, customer disputes etc), review of the minute books, corporate structure, shareholder lists, and tax filings.

Depending on the nature and size of the business, completing due diligence can be a very time-consuming process for both buyer and seller.  Quality and timely information is key – a common reason why deals fall apart is that when completing their confirmatory due diligence, inaccurate data (either intentional or otherwise) causes the buyer to second guess all information provided, leading to delays and disagreements.  This causes a spiral effect of frustration and delays, ultimately leading to deal fatigue and often one or both parties walking away.

Due diligence is a topic we will cover in future blog posts, but the key take away is preparation.  A solid hour spent on gathering, reviewing and presenting quality data can save 3-5+ hours on review and reduce the chances of a buyer walking on a deal.

We would love to hear your story – please feel free to contact us anytime (we are good with evenings and weekend chats)

[1] Jargon Alert- LOI stands for Letter of Intent, a non-binding offer that outlines the initial proposal of the buyer to the seller.

[2] Jargon Alert – Definitive documentation refers to all the legal documents required to complete a transaction.  They include documents like a Purchase and Sale Agreement, Employment Agreements (if key employees are going to be retained by the buyer), Confidentiality Agreements, Non-Compete Agreements, Lease Agreements (if for example a buyer is going to enter into a long-term lease on a property) as well as any Banking or Shareholder Agreements required to complete a transaction.