Editors’ Note: We thank Karl Stark and Bill Stewart (Avondale Strategic Partners) for this great contribution about due diligence. Any deal professional understands keenly the painstaking process that due diligence can be. These seasoned pros take a tough and complicated topic and put it in terms that any business owner can understand.
Preparing for Due Diligence
Karl Stark and Bill Stewart
There is no sugarcoating the fact that oftentimes the most painful part of any M&A process, for both parties, is due diligence. There are steps, however, that buyers and sellers can take to increase efficiency and reduce the time both parties have to spend on the due diligence process.
First, it’s important to understand the central purpose of due diligence. Fundamentally, diligence is performed by buyers on acquisition targets to assess risks/issues and determine if they should proceed with a proposed transaction. This includes a comprehensive review of a business’s corporate records, operations, legal matters, HR issues, insurance, financials, environmental liabilities – it’s an exhaustive list – to determine where a business might face exposure or require additional investment. A less discussed part of diligence is that buyers also seek to uncover opportunities during the process. This includes a review of potential synergies, growth opportunities and more “strategic” diligence to develop a plan for an acquisition once completed.
For sellers, a steady stream of requests from numerous advisors of the buyer can be a severe strain and time commitment, especially when combined with the ongoing need to run day-to-day operations. Since diligence is essentially the last step before closing a transaction, it is usually critical for the business to continue to perform well during the process, placing even more pressure on the target’s management. For buyers, a disorganized diligence process can result in higher advisor costs, more time invested from its management and less comfort that potential areas of liability have been properly investigated.
To avoid these issues, each party can take important steps in advance to better prepare for the scrutiny of due diligence.
Sellers should focus on three areas:
- Records management –Disorganized records will ensure that management spends all its time tracking down redundant documents. Concise, complete record-keeping, on the other hand, can significantly improve the diligence process for both sides and helps parties avoid conflicting views on issues. For example, providing complete extensions and amendments to customer contracts can help avoid confusion surrounding key legal agreements. Environmental records also tend to be very meticulous and voluminous. An organized system of documentation can not only help a seller in diligence, but also with operating the business regardless of a transaction’s outcome. Advisors can help to create a “data room” that compiles all the relevant documents (electronic data rooms are now the norm given the speed, flexibility and efficiency advantages).
- Anticipating issues – Sellers should work with their various advisors (legal counsel, accountants, bankers, etc.) to develop a list of potential issues and explore solutions to them before they become deal breakers. Often referred to as “seller’s diligence”, this allows sellers to perform almost a trial diligence on the business to head off potential problems, or at least to be aware of them. Furthermore, this will allow the seller to potentially discover pockets of opportunities for buyers to present a stronger investment case around why the business is an attractive acquisition. Understanding these value drivers can also be critical to negotiations and the ultimate terms of a deal.
- Prepare early – The earlier a seller can start preparing for diligence, the better. Getting documents in order, working with advisors, and tying up loose ends can all have a substantial impact on the efficiency of the process. One of the most helpful deliverables to prepare is a financial audit, which can limit the surprises uncovered in financial statements. Furthermore, items such as Phase I/Phase II environmental reviews, which often take a long period of time, are useful to develop in advance to reduce the time spent in diligence getting such work completed.
Buyers can also benefit by reducing the time and cost investment in diligence.
These three steps will help them to obtain better quality information:
- Streamlining requests – With the massive amount of requests from a variety of advisors, creating a master list of questions/document requests can be helpful to streamline information flow. Eliminating redundant requests and prioritizing the list can also help sellers focus on important items, rather than the administrative task of marking up a request list with responses. Having a point person who coordinates requests and controls the information flow can also help to ensure that the seller does not get buried (and paralyzed) by request overload.
- Coordinating advisors – Given the number of potential advisors buyers must utilize in a full diligence process, holding regular steering calls can be helpful to assess the status of diligence, identify and prioritize issues, and determine the right solutions to keep the process moving. Facilitating information sharing between parties can also be very useful to keep all advisors informed on issues. For example, legal counsel may uncover a suspect tax position that the financial tax team should be aware of for their analysis, or vice versa.
- Focusing on purpose –Buyers can get caught up in unloading requests on sellers, who may struggle to obtain the relevant information and thus delay the process. Revisiting the purpose of some requests that are sticking points to determine if there are alternate methods to reach the same conclusion not only helps advance diligence past obstacles, but builds some goodwill between two parties working toward a common goal.
Both parties in an M&A must be prepared to invest substantial time and money into the diligence process. No due diligence is 100% issue-free, but taking these basic steps will make it easier for both parties to work together and expedite the process, resulting in a smoother transaction.
Karl Stark and Bill Stewart are Managing Directors and co-founders ofAvondale, a strategic advisory and principal investing firm focused on growingcompanies. Karl, based in Chicago, and Bill, based in San Diego, have acombined 30 years of experience helping businesses achieve and sustainprofitable growth. Their strategic and financial advice helps companies unlockthe value drivers in their business and focus investment around the most profitable growth opportunities. Avondale, based in Chicago, is a high growthcompany itself, and is a two-time Inc. 500 award recipient. The authors thank Avondale’s Sameer Pal for his contributions to this article.
Twitter: @AvondaleSP @KarlStark @BillStewartASP