Due Diligence: your questions answered
Our 2018 webinar Getting your house in order – a guide to Due Diligence certainly got people talking. One of the most popular of our webinar series to date, it tackled what is generally considered a demanding process – “the last great hurdle” of deal-making, as BCMS’ Douglas Edmunds calls it.
The webinar hit a nerve with business owners, and we had too many audience-led questions to get through on the day. Responding to your feedback, the panellists from BCMS and Freeths have taken the opportunity to answer some of your Due Diligence (DD) queries in more detail, below.
The key takeaway? Don’t demonise the process. With the right preparation, support and guidance, DD really can be relatively straightforward.
Here are your questions – we hope they provide some additional insight.
Question 1: How would you advise your clients to prepare their senior managers for a business sale, and who should they expect to bring into the DD process?
Ken Barragan, BCMS: It is important to note that there is a difference between senior managers and key members of the senior management team, so these employees will have to be identified early on. The transaction type, buyer, and shareholders’ aspirations, among other factors, will dictate which team members should be brought into the process, and when, if applicable.
Leon Arnold, Freeths: It's not unusual for non-shareholding managers to be completely unaware of a sale until after the event. However, if their cooperation and buy-in is critical to the buyer post-sale, then it may make sense to introduce them at some stage in the process. This may be in the later stages of a deal when there is a high level of certainty that it’s actually going to happen.
Question 2: How should a buyer deal with a seller who does not want to prepare a full DD - with the argument of confidentiality?
Ken Barragan, BCMS: A buyer would expect, at a minimum, early access to key financial information and legal documentation to get comfortable with what they are attempting to buy. At latter stages of the process, it wouldn’t be unreasonable for them to want to talk to some of the seller’s key suppliers, customers, and potentially management team members.
Anything that unreasonably prevents access to these will unsurprisingly result in potential price chipping, larger deferred and/or earnout amounts, and demands for longer time periods by the buyer for existing shareholders to support a transition of the business post-completion.
Leon Arnold, Freeths: It will be nigh-on impossible to sell a business without it undergoing some level of DD and disclosure. The key is to release the right information at the right points in the process, and to ensure it’s all supported by a robust Non-Disclosure Agreement (NDA).
Douglas Edmunds, BCMS: A buyer will either refuse to go forward, or lower/restructure the price, in order to derisk the lack of information.
Question 3: Is there any advice that you can give about conducting DD on young companies/start-ups, i.e. where the financials are sparse or the company may not yet be in profit?
Ken Barragan, BCMS: While a lot of the information requirement/demands will likely be the same, preparation is perhaps even more important in these cases. Highlighting the growth opportunities and the business plan is all well and good, but this must be robustly supported by detailed pipeline, orders, and strategy (eg capacity utilisation, capital expenditure to support growth/expansion) underpinning your future projections.
Douglas Edmunds, BCMS: On the financials, focus more on future revenue - either contracted revenue or quantifiable opportunities. To help evidence this, some clients put a ‘likelihood of success’ percentage against each opportunity, to give an indication of potential revenue.
Question 4: What are the pros and cons of outsourcing your DD exercise? When would you suggest it is better to use a consultancy to conduct DD rather than doing it in-house?
Ken Barragan, BCMS: This varies on the company’s activities, the complexity of operations, state of finances, internal capacity, and the buyer itself. In fact, some buyers might demand third-party DD assistance (some Private Equity (PE) firms, for example). A consultancy can help streamline the process and alleviate time pressures on the seller, but this comes along with costs and other important demands that must be carefully considered with the seller’s M&A and legal advisors. Ultimately, the buyer will want to conduct its own DD, or rely on vendor-produced reports (at the seller’s cost).
Leon Arnold, Freeths: It’s reasonably common for a buyer to outsource some components of DD. For example, we often see major accounting firms engaged to conduct financial and tax diligence. On the seller’s side, there is no substitute for historical knowledge and context, so the only party likely to be able to assist will either be an existing employee or an established external accountant who already knows the business well. (Bringing a Finance Director into the loop can be well worth it. As an aside, they may well see the process as an opportunity to gain experience in a new area, as well as to impress their potential future employer!)
Without pre-existing knowledge, a vendor may spend almost as much time explaining the background and directing the task as they would if they simply did it themselves.