M&A Due Diligence Preparation

Jacob Orosz Portrait
by Jacob Orosz (President of Morgan & Westfield)

The Importance of Preparing for Due Diligence

Due diligence is the buyer’s investigation of every aspect of your business. Due diligence is conducted in three primary areas:

When a seller doesn’t prepare for due diligence, it can turn into an expensive and time-consuming undertaking. However, there are many advantages to preparing for due diligence, and we believe this is a crucial step in selling your business quickly and for peak value.

The Purpose of Preparing for Due Diligence

The primary purpose of preparing for due diligence is to address potential problems before placing your business on the market. In order to attract a sophisticated buyer to your company, you must prepare for the due diligence process well before you begin the sale process. This is especially true for middle-market companies, as conducting pre-sale due diligence may be the difference between receiving a good price and losing a deal altogether.

Benefits of Preparing for Due Diligence

Resolve Issues Before They Become Issues

When a buyer decides to pursue the purchase of your business, the buyer will conduct their own due diligence in order to determine what is really going on with your business before they commit to purchasing it. Unexpected issues that arise in the course of the buyer’s investigation may potentially kill a deal.

A seller can resolve many of the issues before a buyer ever learns of them with advanced warning of any unsettled problems. Further, a problem identified in advance that can be explained will keep the seller’s credibility intact.

Preparing for due diligence enables the seller to work out problems before a buyer comes into the picture. There is nothing worse than spending time and money preparing and marketing your business for sale and finding a qualified buyer, only to lose the buyer because of an unforeseen problem with your business that could have been resolved beforehand. This scenario happens more often than sellers realize because, despite working in their business full-time, owners are often unaware of seemingly simple issues.

But, those simple issues can have a material effect on a buyer’s perception of the relative risk of a company if they are not resolved in advance.

For example, issues with financial records, if not addressed beforehand, usually trigger demands for a lower price, more restrictive deal terms, or may cause the buyer to walk away from the sale entirely.

Greatly Improves the Odds of a Successful Transaction

It allows your adviser team to correct potential problems and help avoid pitfalls to a sale before you expose the business to buyers.

With inaccurate financial records, you run the risk of losing a buyer because, by the time the buyer discovers the defects during due diligence, the sale must now be delayed to address the problems. After spending many months finding a buyer, losing them over something that could have been corrected from the outset is a huge disappointment and a waste of valuable time, money, and resources.

Retain a third party to examine your financials — profit & loss statements, balance sheets, and federal income tax returns, and to scrutinize key ratios, trends, and other data, and provide you with a report of their findings. This helps spot potential issues that a buyer may find with your financial records and allows you to address these issues before you ever receive an offer.

Speeds up the Due Diligence Process

Having your financial records in order before selling your business also potentially speeds up the due diligence process once you have a buyer, resulting in a higher chance of closing the deal. This is because a buyer who has issues with your financial records will most certainly conduct due diligence very thoroughly, looking for problems in other areas as well.

Maximizes Your Sales Price

Conducting pre-sale due diligence maximizes the value of your businesses by identifying issues early on to avoid complications that can affect the transaction.

Accurate financial records may also maximize the sale price of your business by attracting buyers who are confident in your business. Simply put, the more organized your business’s financial records appear, the quicker you are likely to sell your business and receive top dollar.

A thoughtful evaluation of the business before the sale process begins will make the undertaking more manageable, efficient, and cost-effective for a seller.

Additional Advantages of Conducting Pre-Sale Due Diligence

  • Prepares the business and management for a sale
  • Helps accelerate the sale process
  • Optimizes the price and structure of a prospective transaction
  • Helps eliminate surprises and their resulting delays during the sale process
  • Allows the seller to control the timing and presentation of information
  • Gives the seller extra leverage throughout the process. Buyers, by contrast, use problems to generate leverage.
  • Provides the seller an opportunity to fix problems and increase the asking price
  • Through the process, members of your adviser team come to know and understand your company as well as you do — and far better than a potential buyer. This understanding enables your transaction adviser to prepare a confidential information memorandum (CIM) and other marketing materials that fully describe and highlight the strengths of your business.