Understanding Due Diligence
In the early stages of a process, certain aspects of the company from a financial, commercial, or other standpoint may be shared with an interested party so that they can progress their interest to an indicative offer. Due diligence, however, is a process undertaken once an offer has been accepted and allows the buyer to thoroughly investigate the business and all its relating parts. Findings of this process can then be taken into consideration to assess any potential risks/liabilities associated with the company, but also verify the underlying assumptions in the indicative offer.
Due diligence is presented in many forms, with the more prominent types being financial, tax, HR, legal, regulatory and operational. A buyer may choose to focus on a certain area of the business for due diligence if they feel it is a high risk area and requires an in depth review, but they may also focus on prominent features of the business that are the drivers behind the assumptions in their valuation/indicative offer. Other times, buyers may conduct an overall due diligence for a broader understanding of the business.
The importance of due diligence should never be underestimated with key reasons being justification of the deal’s enterprise value and verify the representations and warranties. Final enterprise value is confirmed to make sure there are no hidden liabilities. Additionally, Intellectual Property (IP) is reviewed to ensure that any IP will remain safe throughout the transaction of the deal and that the value of the IP will not be altered. In certain cases, solicitors also engage in the business transaction, merely to confirm that the items quoted do in fact add value to the business.
The duration of the due diligence process can vary according to the size and nature of the targeted company and may require multiple professionals to handle different aspects of due diligence. It’s also equally important that all the appropriate professionals involved in the due diligence process will need to be well informed prior, in order to avoid delays and ensure preparedness.
An important aspect to consider throughout the process is the target business’s employees. Any due diligence and organisation documents need to be provided or conducted on site, will raise suspicions among the employees regarding a business sale. Consequently, this can negatively impact the workforce and create tension and unease if employees feel their jobs are at risk. Virtual data rooms or private meetings can help to avoid this problem and KBS Corporate can facilitate this to ensure confidentiality is maintained throughout the process.
From an advantageous perspective, the due diligence process is one of the most valuable and key risk management tools used for comparable buyers and businesses. The procedure allows for buyers to investigate the business before making an informed decision and to avoid any surprises at the end of the transaction. The due diligence process also encourages the buyers in ‘caveat emptor’ or ‘let the buyer beware’, which means that it is the responsibility of the buyer to make sure there are no defects in the products, services of the business itself, and that all is fit for purpose and running smoothly. Subsequently, a well conducted due diligence process will ensure the buyer is content and achieves value for the investment.
Also known as side-sell due diligence, vendor due diligence originates from the seller instead of the buyer. This is an independent review of the company before its introduction to the market for a sale. Although due diligence is usually conducted by each buyer independently, more recently, sellers have realised the benefits in conducting their own company due diligence.
The objectives of this process include:
- To develop an understanding of possible risks buyers will find in the business.
- Develop a comprehensive understanding of issues in the company.
- Attain critical opinions on purchase price and company value and possible ways to maximise it.
- Valuable and constructive input to fine-tune and improve the business plan.
- Prepare for buyers’ questions during their due diligence (explain circumstances that will be questioned by prospective buyers).
- Vendor due diligence will allow sellers management to focus on the daily running of the business rather than a distraction by the process of a business sale.
- Increase the chances of selling the company successfully.
More importantly, when there are various interested buyers, having consistent reporting and documentation can reduce the time required for the sales process. It can enable higher response rates and minimise obvious questions. This will ideally increase the quality of offers received as well as maximise the value of the business.
Working with an M&A adviser that understands the fundamentals of the due diligence process cannot be overlooked as an important factor when choosing your representation. Although this process is largely carried out independent of the seller’s advisers, the ability to efficiently facilitate and interpret the flow of information back and forth can ultimately decide the overall effectiveness of the process, and result in a successful conclusion to the transaction.
Tom Eatough, Associate Director at KBS Corporate, gave his insight: “Given the volume and nature of the information requested, due diligence is very demanding and can feel somewhat of an intrusive process.
“As an advisor, I aim to ensure my clients are well informed, prepared, and comfortable with what the process entails. It is important to ensure data is collated and presented in a confidential manner whilst maintaining momentum in the transaction and not frustrating the process. Guidance on best practice is essential as a lot of time and effort can be saved if responses are comprehensive, precise, and referenced correctly. Utilising a virtual data room not only helps us organise the data, but is a useful tool for managing access rights, tracking buyer activity and maintaining confidentiality.”