The Importance of Sell-Side Due DiligenceApril 21, 2016
Thinking about selling your company? You might want to consider performing due diligence.
Due diligence isn’t just for buyers anymore. It’s becoming more important for companies thinking about selling to perform due diligence prior to soliciting offers from buyers. This may seem counterintuitive to a seller, who knows the company’s workings and, therefore, may feel like it’s the responsibility of the buyer to ensure that it’s comfortable with making the deal.
The problem is that buyers are examining acquisition targets more closely than ever. So where a buyer once may have written off what might have historically been considered a “minor” issue, the issue now could take on greater importance and even threaten the deal’s success. Sellers need to devote as much time and resources to due diligence as their buyers do, because the last thing they want is a surprise. Sell-side due diligence provides other seller benefits, too.
What Is Sell-Side Due Diligence?
On the surface, sell-side due diligence isn’t that different from buy-side due diligence. Both parties are essentially looking for the same thing: any issues in the selling company that could present a potential problem for the buyer.
The difference is in perspective. For instance, a buyer is looking for things that could negatively affect a seller’s earnings before interest, taxes, depreciation and amortization (EBITDA). A seller, however, is also looking to find add-backs that could increase EBITDA.
Other Reasons for Sell-Side Due Diligence
A seller running an in-depth analysis of its books could discover errors or unrecorded tax liabilities, for instance, that would raise a red flag with a buyer’s due diligence team. Ideally, the seller could correct these issues before the deal got well underway. At a minimum, if these items couldn’t be resolved before the seller begins to solicit offers, they could be disclosed to potential buyers so that they could be negotiated up front.
Key Components of a Sell-Side Diligence Project
While a sell-side diligence project involves many things, here are three key components:
- Legal analysis. Check for potential or ongoing lawsuits, copyright disputes, regulatory violations, etc. Make sure all “handshake” deals with employees/customers/clients are formalized and properly documented. Also make sure all corporate documents are in order, including stock registers, board minutes, customer contracts, etc.
- Accounting analysis. Calculate EBITDA and review for any potential adjustments. Ensure revenues and expenses are properly recorded and that the most recent accounting period is closed and properly reconciled. Be prepared to provide historical balance sheets, income statements and cash flow statements for the past three years at a minimum. Be sure all supporting ledger reports are in order and properly reconciled (accounts receivable, inventory, accounts payable, etc.). Be prepared to justify collectability of receivables and inventory valuation.
- Financial statements and tax returns. Many buyers will prefer to see that the seller has had their financial statements audited for a number of years. If you haven’t had your financial statements audited, discuss with your advisors and determine if it is worth the investment. Make sure all tax returns have been timely filed, and be ready to disclose any ongoing tax examinations.
Getting It Right
The above covers only a small sample of items that need to be considered. It may take some time for sellers to perform adequate due diligence. A third-party advisor can provide invaluable assistance and advice. We can help you evaluate your options. Please contact us for more information.