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Selling a business: Get due diligence right

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2nd May 2013
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Most of you will be familiar with what due diligence is and many of you will appreciate that it is often a difficult process from which many buyers and sellers struggle to derive value.

Roxburgh Milkins’ Charles van der Lande considers how it should be approached and gives some tips for surviving the process.

Is due diligence inevitable?
Any prospective buyer of a business should want to be sure as possible that the business is worth what they are paying for it. It is therefore understandable that they will want to kick the tyres and carry out some investigations about the business, its assets and people. 

If you want to sell your business it is possible that you will find a buyer who is willing and has the money to just write a cheque without doing due diligence. However, especially in these economically difficult times, buyers like this will be few and far between.

Five tips for surviving due diligence for sellers

· Assume it will take time and be comprehensive. If sellers start with this mindset then they can prepare accordingly and are less likely to be frustrated

· Put yourself in the buyer's shoes. A seller should ask itself what questions a buyer is likely to ask and make sure that these questions can be answered 

· Get organised early. Prepare early, well before potential purchasers are approached

· Resource it. Assume due diligence will take time and then work out who is going to be responsible for fielding the different questions that will come in

· Present solutions. If there is a problem area, either resolve it or present a solution at the outset

We often find that even if some people on the buyer side are willing to proceed with minimal due diligence (perhaps a director who is championing the deal at a commercial level) often they are unable to do so because others (funders, shareholders and the main board) require thorough due diligence. So don’t just accept at face value any assertion that due diligence will be 'light touch' or 'limited' – make sure all stakeholders on the buying side agree with this.

What the reality of due diligence often is
Due diligence can certainly be a painful process for buyers and sellers alike: it can consume a lot of time and result in high professional fees. We have been involved in plenty of deals where this has created friction between the parties: "why is your lawyer/accountant asking this irrelevant question – can’t we just get on and sign the deal?", or "why is it difficult to provide this basic information which you should have at your fingertips?"

In addition, it's a common complaint that the only persons who receive value from the due diligence process are the professional advisers who conduct it, with the sellers, buyers and target business, having got little of genuine use from the process.

Collaboration not confrontation
Sellers should assume from the outset that any buyer is going to want to investigate every element of the business and will only proceed if they have all the information that they need. If a seller does this then his interests are likely to be aligned with those of the buyer: they both have the aim of all relevant information being in the open.   

A buyer who is invited to see everything about a business is likely to have confidence that the seller has nothing to hide and, as a result, trust between the parties should grow. In contrast, if you have a seller who is unwilling or unable to provide information the opposite is likely to happen and it may actually mean that a buyer feels it needs to conduct more thorough due diligence.

Cracking old chestnuts
Sellers are sometimes tempted to assume that a buyer won’t find out or won’t be bothered about a particular issue. Sometimes this turns out to be right but, if it isn’t, the consequences can be significant – the buyer can decide not to proceed or the deal terms can change significantly.

From a legal perspective, we find that the same issues come up time and time again which cause problems in due diligence. Often these issues are ignored or overlooked until late in the sale process.  When this happens, mistrust between the parties can creep in and renegotiation of deal terms and price reductions become much more likely. Whereas, if the issues are identified and dealt with up front it is often possible for them to be resolved in a way which does not disrupt the deal process or terms.

Examples of these types of issues include:

  • Inadequate documentation for customer and supplier contracts
  • Inappropriate employment contracts for key members of staff
  • For intellectual property-rich business (such as those that develop software) inadequate evidence that the business owns/has the right to use IP
  • Dilapidations liabilities on leasehold properties which have not been provided for
  • Irregularities with share capital, where legal formalities have not been complied with

AccountingWEB members will have advised both sellers and buyers of businesses in relation to due diligence. Please share your experiences and insights. What issues do you see regularly? How do you advise your clients to prepare for due diligence?

Charles van der Lande is a partner at law firm Roxburgh Milkins.

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By grimsdalesallen
08th May 2013 11:41

DUE DILIGENCE

Yes...my own experience of buying a small practice led me to include 'Due Diligence'  in my book. [not published yet] All aspects of the business arena and a Balanced Scorecard are included. 

I relied on the trust of the agent and the seller in part. From my own perspective,it involved little attention to prime-entry records and the macro-market. Finally, it ended in litigation when cash-flow became impeded. That is, when client income is less than cash receivables as described on the debtors list...I should have known better!

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By elwarren
16th May 2013 12:45

Due Diligence

 

Thank Charles for posting this useful advice - we worked together on a deal some time ago (I was your client), so I know from experience that you work in a very supportive manner and take the time to understand your client's needs.

To me, whether you are buying or selling, appointing a good professional adviser can pay dividends.  It's important to ensure that you feel comfortable with the person you appoint, as rapport is the first step to trust - and when you trust your adviser, you give them the freedom to act as they need to on your behalf, which ultimately delivers better results for you.  It can sometimes feel like a bit of a dance, but a good adviser will help you ensure that you know which points are worth sticking on, and the ones where a bit of compromise goes a long way.

The preparation of a due diligence file in advance makes it so much less stressful, there are some standard headings for the key paperwork you will need, and it will also highlight gaps in your paperwork and give you the time to identify a way forward.  If you were the buyer, imagine how much more confidence you would place in your potential purchase if everything was neat and organised.

I'm interested to hear other people's experiences as well, I'm sure there will be some good tips and hints out there.

Emma Warren

Portfolio Directors Ltd 

 

 

 

 

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By silicondale
16th May 2013 14:57

IP rights

I was a founder, and chairman of a software company between 1981 and 1993 (let us call it company A). That company under new management has recently been sold to a large Canadian group. However, I am sure that the buyer's due diligence was flawed. Not only did they never approach me for information on the IP rights - which are complex (some owned personally by me, some by academics at various universities, some by other consulting and software companies: I know 'where the bodies are buried'), but in informal contacts I have had with the new owners, they seem to be under the impression that they own all the IP rights. This is probably because the management  of company A between 1993 and today has changed, and the IP paper trail has probably been shredded, even though this is a type of software with a very long 'shelf life'. However, an assertion of ownership without the evidence to support it is insufficient - and the buyer should not have accepted company A's assertions of ownership at face value. The due diligence process entailed failures on both sides. The buyer is now vulnerable to potential litigation from the various real owners of the IP rights. Some professional help beyond just box-ticking would have identified the potential problems without too much effort - the authors' names (and affiliations) are generally included in comments within the source code and in associated documentation.

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By jiatbanus
16th May 2013 14:35

Buying or Selling!

I almost got sucked into writing down some of my personal experiences over the past 40 plus years as Accountant, Adviser, personal Buyer and Seller, in a few countries. Sorry - I'm too old now to commit so much time!

Why do I keep getting involved?

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By Charles van der Lande
22nd May 2013 16:24

Thanks for the comments

We're very interested in the issues that people have come across personally which have caused problems on sales and purchases. Of course every deal is different but it's surprising how often the same issues come up again and again and how often fairly basic things aren't identified and dealt with in advance. 

Perhaps part of this is sometimes a feeling on the part of the participants that advisers (lawyers, accountants and the like) don’t get commercial rationale for the deal and are raising irrelevant issues.  The problem with this attitude is that it fails to recognise that if advisers aren’t happy then it can make it much harder for deal to progress; e.g. is a bank going to fund an acquisition if a dd report lists a load of unanswered questions?

silcondale highlights IP ownership, yes, it's surprising how many times people don’t do their homework on this (either sellers or buyers).

Go on jiatbanus, would be interested to hear what you're experiences have been!

Hello again Emma, you were well organised and, from memory, I don’t think anything came up during the sale process that was a massive surprise to us.  Incidentally I still remember the excellent lunches you always put on for us when we came to visit!

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