Sunday, 20 October 2013

Surviving Due Diligence

First Published July 2013

Although the term “Due Diligence” (DD) applies to any investigation prior to signing a contract & can even apply to a duty of care process, it is most commonly used in respect of the evaluation carried out by a potential purchaser, before an acquisition or significant investment.
 
It takes many forms but is normally carried out by the purchaser directly, by reporting accountants & or by the purchaser’s solicitors. There may well be the need to involve other professionals, possibly including IT consultants, property professionals, environmentalists & or an almost endless list of possibilities, depending on the complexity of the businesses. Professionals in each speciality are often employed by both parties, asking the questions, providing responses, evaluating answers & asking follow up questions.
 
The process is costly, almost always invasive & normally stressful for both parties to the transaction. Not only is it true that most potential transactions fail, it is also true that most transactions fail during due diligence. Getting it right, which means effective & quick, is important to both sides.
 
Top Tips for a Successful Outcome
 
Sellers need to prepare early. Preparing your business for sale not only includes profit & value maximisation but also includes preparing the responses & marshalling the data for those questions which it is possible to anticipate. You can’t predict everything, but you can predict the obvious & can prepare the data, trace the supporting documents & explain the anomalies before the DD process has started, thereby reducing time scales, reducing stress levels, impressing & supporting the purchaser’s confidence levels & improving the likelihood of success.
 
There is no such thing as a “light touch” due diligence. At some point in almost every transaction, the purchaser will tell the seller that they have instructed the professionals to carry out a “light touch” DD. But it never happens. Even if the purchaser actually does ask for a light touch, the professionals involved have to worry about their professional negligence insurance & will place pressure on the purchaser to allow them to carry out an extensive investigation & however well intentioned, most purchasers will follow the strong advice given by their advisers.
 
Choose your professional advisors carefully. This tip is important for both purchasers & sellers. Almost every professional adviser will claim that they are experienced in DD work, although many aren’t. Always ask questions & seek examples of previous work. Expect a firm to have specialist partners & if they don’t, wonder how much DD work they get involved in. Meet the other members of the team, as it is they that are doing most of the work & interfacing with the other parties in the transaction. As well as ensuring that the advisers are experienced in DD, ensure that they are not too big for the scale of this transaction – you will save money & improve the likelihood of a successful outcome.
 
Respond quickly, respond accurately & document everything. Not only does the DD process help the purchaser to maintain (or even improve) confidence that they are doing the right deal at the right price, the answers will have a direct impact on the wording of the Share Purchase Agreement & in particular, the warranties & indemnities. Wherever possible, you should also take notes & then confirm all conversations with a written record.
 
Manage the professionals. Again, this is equally important for both purchasers & sellers. If properly chosen, the professionals firms should be experts in their field, but are unlikely to be experts in your field. Equally, the professional people that are asking the questions & possibly preparing the responses are likely to be more junior & less experienced than you might expect. Many of the questions will reflect their lack of experience & lack of understanding, as will many of the answers. Even when the questions are “sensible” & the answers accurate, there is lots of opportunity for the professionals to misunderstand the responses or misinterpret the implications. Both purchasers & sellers need to keep a close eye on their respective advisers, to anticipate “ill advised” questions, clumsy answers & mistakes in interpretation. Check everything & don’t allow the often understandable mistakes to get in the way of the transaction.
 
Love the other side. Every sales process that involves an extended gap between agreement & completion suffers from a phenomenon called “buyer remorse.” Well known to both new car sales personnel & estate agents, the purchaser begins to regret the decision to buy & these feeling of remorse are exaggerated by the length of the time scale involved. With a company sale, the room for buyer remorse is exaggerated by the extended time scales, by the DD process & by any changing circumstances, whether it be the target, the purchaser,  the market or the economy that is changing. Whilst the purchaser is experiencing “buyer remorse”, the seller may well be experiencing “seller remorse”, a phenomenon that probably only occurs with sales of personal property, be it a house or a business. When you add in the particular invasive issues around DD exaggerated by the commitment to fulfil the DD process whilst continuing to manage a business, it is little wonder that seller remorse is such an important issue in every transaction. The solution is for both sides to meet often, empathise with the other’s issues & look to resolve problems before they become barriers.
 
Hang Tough. Most transactions experience problems & any issues are exaggerated when they are applied to family businesses where the emotional attachments are that much greater. By keeping the focus on the end result, a business that has been professionally prepared for sale & which is fully supported through DD will come through & realise real value for the vendor & for the purchaser

Bob Drew is a Commercial FD with over 30 years’ experience in business. Having bought several businesses & sold a few, Bob has lived through a significant Exit when a large family business was sold to a private equity firm. The above Tips are borne of experience – they are not lifted from a text book.

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