Reparing For a Due Diligence Review
When you are preparing to sell your business, you should have an independent reviewer look at your company to ensure that you are prepared for the Due Diligence Review (DDR) that will be conducted on behalf of the purchaser. Many potential sales of businesses fall through or are renegotiated when the DDR reveals undisclosed information or the closing is delayed while these issues are resolved.
In a recent discussion with James Phillipson, a founding Principal of Mastermind Solutions Inc. he said, “In the ongoing day-to-day running of a business, many potential obstacles may have been accepted by the current owners and are not top-of-mind, but will likely be discovered in the DDR process. The seller can obtain a much better outcome by determining the likely issues and strategizing and preparing for a smoother DDR.”
There is a large amount of documentation, hard copy and electronic, that is required for a DDR, regardless of the size of business. Murphy’s Law dictates that a DDR will interfere with some of month-end, quarter-end, year-end, budget preparation, vacations, etc. Preparing in advance by anticipating what will be required is going to facilitate a smooth process with a minimum of delays. The management team should assemble a data room or space for all the documents that are likely to be required by the DDR.
In preparation for annual financial statements, many mid-sized businesses allow for the accounting processes to stop short of the adjustments that will be provided by the external accountant. Where these entries include a routine “clean up,” this can delay the DDR as the reviewers calculate the true results and cash flows. The pre-DDR will identify the adjustments and implement processes to ensure that these become part of the routine accounting to avoid delaying the DDR.
In addition, the DDR consultant will report back to their client, the potential purchaser, on all that they discover so it makes sense to be prepared. In my discussion with Phillipson he stated that “in many mid-sized businesses three factors often have not kept pace with the growth of the business: descriptions of responsibilities; approach to documentation; and processes. These will reflect on the quality of management.
A pre-DDR review will identify many areas of weakness and give the selling management an opportunity to take steps to remedy the issues so that they will no longer become issues during the DDR. The quality of management, processes and controls will inevitably influence how readily documentation is available at the outset, how the issues that arise and requests for additional documentation are dealt with and the perspective gained in reviewing the material provided. This will speed up the DDR and reduce the risk of the issues giving rise to renegotiation of the purchase price.
Of course there will always be issues arising in a DDR, in fact many. How the vendor responds can have a material impact on the results. Preparation for a DDR reduces the risk of the DDR continuing for a longer period which has a much larger impact on the seller than the purchaser. It is common for the vendor and their staff to allow the day-to-day operation of the business to slip. They might be de-motivated as they anticipate a change in management and staffing and are overworked or feel scrutinized as they attend to the many issues that arise.
As a DDR extends over a period, from a few weeks to a few months, the reviewer will maintain a vigilant eye on the key performance indicators of the business. If they start slipping it will provide fodder for the purchaser to renegotiate the purchase price to reflect those lower results and the increased risk to the purchaser.
Mark Borkowski is president of Toronto based Mercantile Mergers & Acquisitions Corporation. Mercantile specializes in the sale of Canadian mid-market businesses. He can be contacted at www.mercantilemergersacquisitions.com