Manage Buyer Due Diligence

Prepare for and manage the Due Diligence process to ensure a timely and successful closing.

Objective

Satisfy the buyer’s need for relevant and accurate information. Show the buyer everything you represented about the business is true.

Tasks

Set up a virtual data room. Upload all relevant files into folders. Be responsive to buyer requests for records and meetings with the appropriate people. Remove the contingencies to closing. Ask for a draft of the Purchase Agreement (Step 13) or circulate your version of the Purchase Agreement to the buyer.

Best Practices

Due diligence is about verification. It’s an opportunity for the buyer to verify your business is what you purported it to be and what they believe it is and/or can be. It’s an opportunity for you to verify the buyer has the financial ability and business acumen to complete the acquisition, run the business, and what they will be like to work with post- acquisition.

The Due Diligence step is perhaps the most critical one in selling a business. It is where most deals fall apart. It’s not just about fact-checking and verification, however. It can be influenced by emotions. Buyers and sellers can easily get sidetracked by ego, fear, and pride. The onus is on you as the seller to manage your emotions and perhaps neutralize the negative emotions expressed by the buyer. Keep your eye on the prize – the CLOSING!

After you accept the best offer, the Due Diligence Step should commence immediately. The offer will probably be non-binding and subject to completion of buyer due diligence. Do not let them drag it out. If you completed Step 11 properly, the offer came with a deposit and a deadline for finalizing the purchase. It’s up to you to insist this deadline be met, or you are prepared to go back to market and engage with other interested buyers. Trust me on this point. Many buyers will drag their feet and then ask for an extension a week or two before the deadline expires.

The main reason buyers drag their feet is because they are scrambling to pull together the financing and the expertise needed to make the acquisition. They are coordinating with their own team and with their professional advisors. It can be a challenge for them to get others to focus on the deal. They may be waiting to hear back from their bankers, partners, or investors. There may be multiple people and resources the buyer needs input from but may not be able to control. You can be sensitive to this challenge and commiserate with them, but do NOT let them make it YOUR problem.

Below are some general best practices for managing Due Diligence and keeping the deal on the rails. Aside from having a virtual data room where relevant and confidential records are shared, the most critical aspect of Due Diligence is face-to-face meetings between the buyer, yourself, and your employees. Some meetings may also involve your vendors, landlord and key customers. These face-to-face meetings are usually where things go awry. Records are records, but personalities are unpredictable.

Things to keep in mind when meeting with the buyer and/or discussing the deal by phone:

1. The deal is not done until the money is in your bank More than half of all business sales fall apart during due diligence. Always be selling and always be negotiating. Stick to the timeline!
2. Know as much as you can about the buyer, especially their key business Know the players in the room, particularly the chief decision maker. Who has the power to confirm or kill the deal?
3. Chemistry and rapport can make or break a deal. No matter how good the numbers look, in the end a buyer wants to know, “Is this a good business proposition? Can we work with the owner and/or team who might be staying on post-acquisition?” Be cordial, be professional; never defensive or arrogant during the discussion.
4. Understand the buyer’s primary motivation for the acquisition and answer every question in a way that reinforces the opportunity for the If possible, surface additional opportunities for the buyer that the acquisition could bring them that they may not know about or have thought about. Aside from a good team and solid clients, what additional value could you bring to the buyer’s company? Don’t just sell what you have, sell futures.
5. Be transparent about your weaknesses (refer to them as soft spots or areas for improvement), but always play to your company’s Reinforce how the buyer’s strengths compensate for your weaknesses and vice versa. Stress how you can help shore up THEIR soft spots.
6. Visuals Have an org chart handy, be prepared to discuss key people and their roles. Have a list of major clients by revenue and profitability. Have a list of high value client targets, or former clients who should be reengaged post acquisition. Try to provide new, positive information, they may not have seen in the Teaser and Selling Memorandum.
7. Be sensitive to the “culture” of the buyer’s people and The buyer likely operates differently than you operate your company. In fact, the cultural differences between geography and industries may come up. Think about how to address this and how to bridge cultural gaps. Remember, more than half of all mergers “fail” post-acquisition due to poor integration of products, services, people, and processes. They may know this fact and will be thinking about how to minimize fall-out and ensure a successful transition.
8. Be prepared for them to bring up “problems” and “concerns” uncovered in their due Things like lack of revenue, shrinking margins, slow growth, flat client engagement metrics, expiring contracts, potential loss of key clients post acquisition due to unforeseen conflicts, loss of key employees, etc. These are all ways in which buyers may try to set the stage to renegotiate the price or terms. Don’t get defensive; acknowledge fact, deflect unsubstantiated or imagined concerns, and outline points for addressing the issue. Hold your ground! Of course, if there is a material issue that could substantially impact valuation, don’t dismiss it as unimportant. Be open to how the Purchase Agreement could be structured to compensate for it.
9. Be on guard against any requests the buyer makes to speak with employees or clients without you being present; non-material information, or requests that create “busy ” For example, a request to construct financial models or projections, draft a marketing/sales plan, or write job descriptions for new hires the buyer wants to make. Deflect work they should be doing for themselves. Stick to the agreed upon due diligence list of material facts. Politely let them know you are too busy performing against income-producing work and/or serving your customers, to be distracted by work that they should do themselves for post-acquisition integration, planning, and growth. A good rule of thumb is to only be responsive to requests that are required to get the deal done, not those that help them plan or manage the business post-acquisition.

10. There is no such thing as a casual or stupid Don’t underestimate their sophistication. They may be very good at acquiring third-party assets and extracting the highest value. They won’t pay a single dollar more than they have to pay. Assume every line of questioning has a purpose, including those that seem non-business related.
11. Meeting the REVENUE and EBITDA target for your business will make it easier to negotiate the purchase Any sales incentives that further that goal which do not create strain on the expense / liability side of the ledger should be considered.
12. The internal announcement of the pending acquisition and how it will impact the employees should be orchestrated very carefully. Remember, the company is under strict NDA not to disclose the pending transaction to anyone, so this needs to be stressed and only those who need-to-know should be It must be impressed upon employees not to talk about the pending acquisition to colleagues, clients, etc. The worse thing that can happen is the media writes about it on a tip. Be prepared for an official response if the pending transaction does leak out.
13. Cooperation from key employees could make or break the Take care that a key employee realizes he/she can hold up the deal and make outsized demands. The owners may want to consider reasonable incentives for key people upon a successful closing. I’ve seen deals fall apart because the seller’s key employees did not cooperate with the buyers and sabotaged the sale.
14. Take care to make sure the buyer does not start talking with the employees, customers, or vendors until and unless you have made the intro and teed up the conversation If possible, be in on all meetings between the buyer and the company’s stakeholders.
15. If there is a financing contingency in the offer, it should be monitored The buyer’s prospective financiers could place conditions on them that could create problems in due diligence or the final docs, such as employee retention and onerous terms for the earn-out.
16. Remember, due diligence is CONFIRMATORY in Resist all attempts by the buyer to distract you with creating, planning, forecasting and post integration issues. Anything the buyer asks for should be a MATERIAL FACT. Avoid any attempts to make you scramble around to assemble nonmaterial information. Challenge any request that is busywork or designed to further the buyer’s objectives post-acquisition.
17. Purchase Agreement (aka Definitive Docs). The buyer will likely want to create the set of documents to be signed at closing, conveying the assets to them and paying you for the Ask them about using a “standard set” that is buyer-seller neutral. Using a standard Asset Purchase Agreement can save both parties a lot of money. Using a custom set provided by the buyer could cause you to incur substantial legal costs. See Step 13.
18. Keep the momentum Be responsive and cooperative and insist the buyer do the same. Insist they stick to the 60-day closing timeframe. The more you delay in sending them the docs they request, the better argument they will have for delaying the closing. Resist any attempt by the buyer to slow down the process. Time ALWAYS favors the buyer. The more time that elapses in a deal, the more likely things can go wrong for the seller. Use your lawyer or other intermediary as the bad guy – don’t be the bad guy yourself. Remember there are always more fish in the water. Don’t agree to extend the LOI and due diligence step or closing, unless they pay you to do so.

19. Keep back-up suitors who have signed your NDA warm. You cannot entertain another LOI or engage in any kind of negotiations with other buyers, but you can keep them apprised of the progress of the sale in the event it falls through. You can also keep your listing on the
20. Finally, retain legal counsel to review the definitive docs and represent you at the Most buyers are honorable, but some are not above pulling something at closing that negates the value of the deal for the seller and enhances the value to them. A good attorney can help short circuit any antics and ensure you get the deal you bargained for.

Tools and Tips

A secure virtual data room can be set up using Dropbox, Google Drive, or any number of other solutions. It’s important for you to control access to this account. Organize it into folders. A sample outline of folders is included in the Examples in the back of this book. Make sure ALL documents loaded into these folders are marked CONFIDENTIAL.

IMPORTANT: If there is something on the buyer’s due diligence list that you don’t have, or is not relevant, tell them right away and have it taken off the list immediately, so it does not become an issue later. You don’t want to be two days before closing and then get a message from the buyer that they are still waiting on you to deliver XYZ, but you don’t have XYZ.

There should be no surprises in due diligence. If something negative surfaces, address it quickly and set expectations for the buyer. Repeatedly remind the buyer of how much time is left. Schedule a firm DATE, TIME, and PLACE for the closing. Get it on the buyer’s calendar within 30-days of closing.

There is an exhaustive Due Diligence list in the Example section. Some of these items may not apply to your situation. The items you can be sure a buyer will investigate include the following:

• Financials: The buyer will verify the financial information they’ve already received from They may spot- check inventory. They will look for expenses that may have been deferred in order to boost earnings. They will examine accounts receivables aging and likelihood of collection. They will look closely at accounting methods used.
• Returns, Credits and Allowances: The buyer will want to know if there are any pending returns of goods and services, and if any customers have credits, allowances, or agreements for future
• Unrecorded Liabilities: The buyer will drill down on accrued vacation pay, warranty obligations, unfunded pension liabilities, and unfunded healthcare liabilities for
• Tax Contingencies: The buyer will ask if the business is being They will check to ensure all taxes are current, including sales tax, employee withholding, and unemployment tax filings. They may ask their accountant for an opinion on how aggressive your recent returns were to avoid or lower taxes. They will calculate the risks of a future audit.
• Litigation: The buyer will ask about recent or threatened litigation, especially in product liability.

• Personnel Background Checks: The buyer will run credit checks and a criminal background check on owners or employees expected to stay on post-acquisition.
• Licenses and Permits: The buyer will check on required licenses and permits, if they are current, and any issues that may prevent them from being
• Intellectual Property Filings: The buyer will check on the status of fictious name filings, patents, trademarks, copyrights, and trade secrets.
• Key Business Relationships: The buyer will check on the company’s relationships with suppliers, vendors, and
• Change of Ownership Expenses: The buyer will estimate the costs of relocation and change of They may try to have these costs deducted from the purchase price if they are unusually high.

Summary

Due Diligence is ‘make or break’, ‘go or no go’ for the sale of your business. You (or your broker) must be prepared for it and manage it like a hawk. You should have all the relevant records uploaded and ready BEFORE you accept an offer.

It’s a good practice to engage professionals who can help you prepare for Due Diligence and solve, or mediate, issues raised by the buyer. Keep in mind that the buyer is looking for TRANSFERABLE value and liabilities. This includes products, people, and processes. A well-organized business is not run by the owner. It is run by systems and processes. The systems and processes run the business. The owner runs the systems and processes, and that know-how should be easily transferable to a buyer.

The less value that can be transferred and the higher the liabilities that are likely to transfer, the more you can expect the buyer to walk away or want to renegotiate the price.

Upon accepting an offer, insist the buyer provide you with a Due Diligence list to be attached as an exhibit to the offer BEFORE you sign it. If there are items on the buyer’s Due Diligence list that you do not have, or do not think relevant, have them take it off the list. Agree to allow the buyer to reasonably request additional items later that may be needed after reviewing your records, that are germane to that particular issue, but do not let the buyer use Due Diligence requests as a way to postpone the closing.

Above all, methodically remove all the conditions and contingencies precedent to closing. Get the buyer to remove each contingency in writing as it is satisfied. You don’t want to be negotiating the Purchase and Sale Agreement with a bunch of contingencies outstanding – it could torpedo the deal.

Examples

• Due Diligence Folders List

• Contingencies Often Asked for by Buyers