Why it's essential to prepare for due diligence

At last, we have a handshake with the buyer and have just agreed to the key deal points by signing a written Letter of Intent (LOI). While the attorneys begin to prepare the purchase agreements and schedules, pointing toward a closing date, the buyer will send in its own team of financial, business and legal experts to investigate every aspect of the business it has agreed, in principle, to acquire. Thus begins the long and typically exhausting process called due diligence. By preparing in advance for due diligence the seller can make the process go a lot smoother and faster thus serving the best interests of both parties. The buyer must be confident that it knows what it is buying, what obligations it is assuming, the nature and extent of the seller's contingent liabilities, contracts, litigation risks, intellectual property issues, and much more. The seller can also be reasonably assured that any potential problems down the road are surfaced and dealt with prior to closing. The due diligence period also affords the seller a chance to do a bit of its own due diligence on the buyer particularly if the consideration includes stock in the acquiring company or there is a substantial earnout provision. In certain cases, such as a merger of equals, this "reverse diligence" can be nearly as broad in scope as the primary diligence conducted by the buyer. Following is a summary of the many significant Financial, Operations and Legal due diligence activities that are conducted as part of a typical M&A transaction. Financial The buyer must become satisfied with all of the seller's historical financial statements, tax returns and related metrics, as well as any projections of future financial performance. More specifically, the buyer will pore over the company's financial records for the last several years to fully understand, validate and assess its financial performance and condition. The buyer will also review the company's financial projections and underlying assumptions, including working capital needs, capital and other forms of investment. Very little is exempt from the buyer's thorough examination. Operations Every aspect of the seller's business operations is open to examination, including its strategic fit with the buyer and opportunities for "synergy" savings and incremental sales. The buyer will examine the existing customer base, including concentration, the pipeline of future client prospects and customer contracts. To be sure all necessary steps were taken to protect intellectual property, the buyer's team will also examine the company's full range of products, services and technology, including domestic and foreign patents, licenses, trademarks and copyrights. Later in the process, the buyer may want to actually meet with key customers as well as the seller's own people to be confident they can be retained post-closing. All employee/management issues must also be identified and explored, including any past or current labor disputes. Legal The list of matters subject to legal due diligence is very extensive and ranges from litigation (pending, settled or threatened) to tax matters, environmental issues, insurance, material contracts with customers and vendors, leases, employment agreements, etc. In short, every aspect of the business with potential legal ramifications is subject to intense due diligence. Fortunately, in today's digital world, most of these documents already exist and are stored electronically so they can be made available online for easy access by the seller and his financial, legal and other outside advisors. Equally true, however their accessibility can lead to deeper and more extensive examination of the business throughout the entire process. ----- Ken Collins is managing partner of KBC & Associates, an M&A Advisory firm based in Huntington, New York. Published: Mon, Dec 31, 2018