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Selling your business? Consider sell-side financial due diligence!

INSIGHT ARTICLE  | 

You’ve decided the time is right to sell your business.

You’ve done your homework, have a ballpark valuation in mind, and have retained the services of a trusted and experienced M&A advisor.

Now your attention has turned to putting your divestiture plan into action.

One of the first things that a prospective buyer will ask for is to ‘take a look under the hood’ of your company’s financials – this will allow them to validate the information supplied during the teaser/marketing stage.

Typically, the most persuasive evidence of future financial prospects is based on what was actually recorded in the books historically. This can then be supported by your well-thought out plans, specific projections based on reasonable assumptions, and forecasts to bridge anticipated future earnings (inherently, support for strategic plans tend to be more qualitative in nature). The validity of your starting point will become crucial as you move forward and negotiate the price and terms within the purchase agreement.

As the seller, it is of paramount importance for you to remain at least one step ahead of the buyer - and their advisors. This will help you to avoid surprises, guard against value erosion through re-trading, maintain your credibility with the buyer, and lead to faster completion of the transaction.

To successfully close a deal, sellers need to stay one step ahead

Listed below are a few common themes we’ve noted in respect to sellers that have been successful in remaining at least one step ahead.

  1. Be prepared – collect data and information, which the buyer will ask for, in advance of receiving the request. This will allow you to review the data prior to sharing and outside of the deal ‘pressure cooker’ environment.
  2. Scrub the numbers – the buyer will typically be interested in the last couple of years of financial information and the monthly results for the current fiscal year to date. It is important for the internal numbers to reconcile to the financial statements (audited, as applicable) and the financial information provided during marketing. It is also important for you to understand what drove the historical results, so that you can clearly explain unusual items and the buyer can get comfortable with normal underlying earnings generated by the business.
  3. Dedicate sufficient time and resources – recognize early that the transaction process will place incremental pressure and demands on key members of management. Good time management and planning (e.g. dedicate certain days for management meetings) will allow you to make arrangements to satisfy buyer requests alongside meeting the demands of the day job. It may also be helpful to dedicate a ‘point person’ to funnel requests through and filter your responses for consistency and accuracy.
  4. Manage advisors – set clear expectations regarding deliverables, timing, frequency of advisor updates, such as weekly update calls, at the outset. Management of advisors is particularly important when agreeing to the scope of work and the degree of supervision you need to dedicate.
  5. Be realistic – in terms of business valuation, timing of deal closure, and capabilities of the incumbent management team.

In many instances, we see sellers neglect to ‘scrub the numbers’ in advance, largely due to the company’s in-house finance team not having sufficient deal experience or bandwidth to handle the demands of the deal. This will often result in sellers being caught by surprise when the specialized financial due diligence team (representing the buyer) is introduced to the transaction.

Typically, the buy-side team:

  • begins to piece together financial information;
  • challenges seller explanations; and
  • identifies matters previously unknown by the seller.

All these items can have a detrimental impact on the deal price (through re-trading terms), potentially killing the deal altogether.

Retain a sell-side financial due diligence professional

One practical solution to mitigate this risk is to retain a sell-side financial due diligence advisor. This will help to relieve the incremental pressure from your finance team for the duration of the process, allowing the finance team to focus on their day-to-day operations and execute on supporting value-accretive activities. A dedicated sell-side diligence team will also help to present your numbers and story in a succinct and understandable way, thereby reducing the strain of dealing with buy-side requests and the time it takes to respond (a key driver of transaction duration and efficiency).

Sell-side financial due diligence tends to yield most value when the diligence team is engaged early in the transaction process and has a collaborative relationship with the trusted M&A advisor. We have seen several instances where management has had to scramble to recover after communicating preliminary financial information to interested parties, only to discover it was not supported by normalized underlying financial performance. Unnecessary stress, backpedaling by the seller and increased costs to bridge the preliminary data to the source financial information could all have been avoided if the sell-side diligence team was brought in to work alongside the M&A advisor at the outset.  

In contrast to your dedicated M&A advisor, who will typically focus on marketing and presentation of financial data as part of overall investment proposition, a sell-side diligence team will rigorously review and analyze the company’s historical financial data, to identify key issues, errors or omissions in advance of the buy-side advisors getting involved. The advance notice allows management time to fix errors in the company’s numbers, so that the data will stand up to buy-side scrutiny. In turn, it provides comfort to the buyer: it enhances your credibility and the buyer’s trust in the reliability of your assertions – ultimately increasing the likelihood of achieving a favourable deal outcome.

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