The alchemy of due diligence

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David Martin, a Partner at UK200Group member firm Knill James, explores the important dos and don'ts of the due diligence process.

Usually selling a business is a long term goal and a good UK200Group accountant will have been getting the enterprise into good shape ready for the day when the owner is ready, even if you aren’t always in control of the timetable. But the figures speak for themselves: the integrity of the data contained in the formal accounting ‘bricks’ such as asset value, dividends, cash flow, earning and multiples will be tested during the due diligence (DD) process. In practice any unrealistic vendor expectations of the value of the business can be flushed out by the ‘science’ of accounting.

Perhaps surprisingly, it’s the vendor whose needs will call for a more emotional approach: the art of accountancy. For a prospective purchaser, the ‘value’ that is specific to them is more important than the latest accounts. They will typically be looking for synergies, future income flow, capital growth or a combination of these; and the price needs to represent a better return than would be achieved from investing the same amount in another business.

So there is both art and science is getting the valuation right. Whichever side of the fence you find your client on, the real skill is in minimising disruption and maintaining business as usual during the whole DD process.

But what are the key steps in valuing a business and how do you help clients manage the necessary DD process while maintaining business as usual?

In my experience, a buyer is often more worried about the risks of making an unsuccessful acquisition than they are excited about the potential gains from a successful deal. So due DD, while often the least favourite part of the deal process, is the key – and the lion’s share of the work falls on the vendor. But help them to keep it in proportion!

Due Diligence Dos and Don’ts

• Often a sale is on the vendor’s agenda anyway, so do encourage forward planning. Ensure that the ‘housekeeping’ is up-to-date by formalising contracts, HR matters, books etc: all the things that make the business less risky to the potential purchaser.

• Maintain open channels of communication with the prospective purchaser and their advisors to both speed up the process and build a level of mutual trust and respect which helps a deal progress more smoothly.

• Agree the timetable upfront, establish responsibilities for providing information, and allocate the man hours needed to do so. Divide the labour. Accountants and business advisers can do the legwork to reduce the impact on the running of the business for its owners. Agree fixed fees, if possible.

• Set up a Data Room (share electronic information with the purchasers and their advisors) – this helps to minimise the cost of providing such information.

• Discuss findings with the purchaser or their advisers as they arise – there may be misunderstandings or more information required to clear any issues arising.

• Always remember a deal may fall through and as such ‘business as usual’ is key throughout the whole sale process. You may need some help from the vendor’s finance team but other than that it is usually best to advise your client to keep knowledge of a deal to the minimum to avoid a detrimental effect on the business (uncertainty, distraction, job insecurity, potential to lose key staff etc).

• Spend time and your client’s money on preparing detailed vendor DD until you are asked and you know what format the prospective purchaser and their advisers are looking for.

• Assume the deal is done before it is actually completed – DD results can have an important impact on the price and the final decision whether or not to proceed.

• Don’t be rushed. When discussing the DD findings ensure you are allowed time for a thoughtful and fact-based response. Don’t try and hide any issues within the business until the last minute but ensure that you provide this information with supporting narratives and explanations.

• Ensure that your client doesn’t agree to changes to the contract too early. Something arising out of the DD later may offset any issues, and even support a higher price.

Above all, get it right. Be quick but don’t hurry.

By David Martin, Partner at UK200Group member firm Knill James

Tags: UK200

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