Due Diligence Done Right
Due diligence is one of the most important stages in the sale process. It is during this phase that buyers assess an acquisition target in detail to identify potential risks and decide if they will proceed with a transaction at the terms discussed in the letter of intent (LOI). Proper preparation can help sellers avoid common roadblocks and realize full value for their business.
Financial Documentation
Buyers expect transparency and accuracy when in financial reports. At a minimum level, sellers should be ready to produce Profit and Loss (P&L) statements and Balance Sheet statements for the prior 3 years and trailing twelve months (TTM). Financial statements should be prepared according to GAAP, and all major entries in the general ledger should be backed by supporting documentation. During a Quality of Earnings assessment, buyers will reconcile what is on the financial statements with bank statements and tax returns.
Businesses using cash-basis accounting may need to transition to accrual accounting shortly before a sale. While time-consuming, this shift allows for a more accurate reflection of financial performance, which can lead to a more favorable valuation. Working with a banker and CPA can help recast earnings in compliance with GAAP and establish a reasonable approximation of market valuation.
Legal and Contractual Compliance
Legal issues can derail deals, cause costly delays, or result in a significantly reduced valuation. Before entering due diligence, engaging in legal counsel to review contracts, leases, and other critical agreements could help shore up any legal uncertainties. Intellectual property protection, employment agreements, and any pending litigation should be reviewed and addressed prior to the buyer’s review to avoid unexpected problems.
An experienced M&A banker along with good legal counsel can help business owners prioritize which legal issues are worth addressing ahead of going to market and which can be addressed later. An experienced banker can also advise on the company’s legal structure to optimize a transaction for taxes and liabilities.
Operational Continuity
Beyond financials and legal paperwork, buyers will want to ensure a business can continue to operate at similar performance levels after a transaction and/or ownership transition. Documenting operational processes, organizational structure, and business workflows can provide a clear picture of how the company runs. Further, a business with a management team in place that has a history of solid performance can give buyers confidence in their investment.
For more on preparing a business for Due Diligence, explore our Transaction Readiness guide.
