Merger & Acquisitions Due Diligence Explained
Today we’re talking about due diligence. So, this is a topic that comes up in all sorts of different contexts in the law. Lenders perform due diligence before they give loans and there are other contexts in which venture capital investors will do due diligence on a company. I’m talking about it today in the context of mergers and acquisitions. So if you’re selling your business, this is a concept that you’re going to have to warm up to.
I’m looking right now at a due diligence checklist. So, this is something that a buyer, once they’ve signed a letter of intent or expressed some indication of interest – they feel
like a deal is happening – they would send over to the seller of the business this list of things that they’d like to see. This is organized by topics. It’s got finance, it has legal, operational, strategic, human resources, basically the main functions of the business and then it’s a request for certain documents. Due diligence is the process of kicking the tires and making sure that what you’re buying is what you think you’re buying.
Due diligence can be a pretty painful process for sellers because it’s kind of like a root canal for the business. I mean you’re really forced to gather lots of documents and produce them. There are multiple rounds of follow-up questions if it’s a big business, a large business, and there are big deal teams. The questions can come from all sorts of different directions. It’s common to organize all the due diligence items. So, you would organize responses in to folders. You can do it Dropbox or Google Documents but there are off-the-shelf products out there Intralinks and iDeals and things like that are built for this purpose, but you’re gonna get this as a seller and it’s gonna be a request.
Potential buyers will say “give us an organizational chart, give us financials for the last three years, profit and loss statements, income statements, cash flow statements, give us tax returns, customer lists, top ten customers each of past three years and the total volume they’ve done, give us all your contracts.” I mean it’s just about everything and it can be very, very in-depth and the process could take a few days, it can take a few weeks, it can take a few months for larger deals.
Back in the day before the internet was what it is today, back in the late 90s when I started practicing we would actually do this in physical locations. We called them deal rooms or war rooms where people would get together and there’d be boxes and boxes of these documents, so count yourself fortunate that you don’t have to go through that today.
But it’s still a very involved process, and can be pretty painful as a seller. One way to deal with that is to just understand what’s coming. Get a copy of a due diligence request list and just map out what the buyer’s going to be looking for. Part of this is being organized which will make it easier to respond. If you could do this before you get deep into negotiating the sale of the business that’s helpful. If you know you’re selling the business, start thinking about it this way and in today’s day and age of electronic files you probably have some file structure or system already.
You’re looking for all your contracts, all your permits, leases, you’re looking for HR records – it’s a very, very in-depth process. It goes without saying that you would only provide this information, whether they’re a competitor or not, under the cover of a non-disclosure agreement. That would be very, very common in this context.
As a buyer, it’s not that common to see a deal fall apart during due diligence. It tends to be more of a perfunctory sort of rubber-stamp that the buyer is buying what they think they’re buying or they might find something that’s problematic and causes a renegotiation of the terms sometimes.
The deals do blow out you know – and that happens more if I represent the song and we haven’t let the buyer very under the hood. Maybe they just don’t have a great idea of what the finances and things really look like when you get in there, but for the most part you can expect it’s probably going to be relatively perfunctory. A process where the buyer says “let’s just make sure I’m getting what I think I’m getting.” It won’t make it any simpler for you to deal with. It can be pretty taxing on time, but bear in mind that there’s a light ahead. In most cases this should be a rubber stamp and your deal should hold okay.
You want to avoid major surprises. If there’s big issues, talk about that up front with your council and your advisors. Ask “how are we going to deal with this? When is the proper time to show this? How do we address these things?” And think that through – obviously you have to disclose every major issue when you’re selling your business, anything that could possibly be material, but there is some degree of discretion regarding when you do that and how you do. It’s best if that doesn’t just pop up on someone sort of randomly doing a little due diligence.
And number two, a buyer is looking to make sure you’re organized so some of that process – and your advisors can help you through that – is to show that this business is well-kept, it’s tight, it’s organized, the contracts have every page and they’re signed and stuff like that.
So again, it can be kind of painful from a time and labor standpoint, but it shouldn’t blow your deal on the buyer side of things. There’s no limit to what you can ask for so it’s just kind of what makes sense to see. They come over in this form usually five, six, seven pages – lots and lots and lots of requests – but you’re going to have a short list. As a buyer, things that are particularly important usually look like financial, the contracts with major customers, you know things of that nature.
So, if you have questions about due diligence certainly reach out. If you’ve gotten the point where you’re doing it, congratulations, you’re close to the finish line hang in there.