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7 Reasons to Perform Sell-Side Due Diligence

Andy Schultz EKS&H | August 15, 2017 Expert

Most everyone has heard the phrase “do your diligence,” and most mergers and acquisitions (M&A) professionals are accustomed to obligatory buy-side due diligence. However, sell-side due diligence and transition planning is not as well known.

Sell-side due diligence is a proactive way for sellers and their M&A advisors to ensure the company is presented in the best light possible — and maximize the chances of a favorable price and terms in a deal. Paid for by the seller, sell-side diligence uncovers potential issues and red flags before buyers do, giving sellers time to properly message and/or rectify these concerns before engaging in a transaction.

It can be overwhelming for sellers to try to satisfy buyers’ many requests during the buy-side due diligence process while simultaneously running the business. Too often this leads to missed deadlines and other inefficiencies that can damage the seller’s credibility, cause lower valuations or unfavorable terms, or even kill the deal entirely.

Engaging experienced M&A due diligence professionals on the sell-side can reduce the risk of the buy-side process going sideways, alleviate stress on the seller, and increase the chances for a successful process.

Here are 7 common dynamics sell-side due diligence can uncover.

1. Weak financial and operational data systems

The seller might be using multiple data systems; antiquated systems; or, worse yet, no systems. Getting access to detailed financial information will be priority number one for a buy-side due diligence team. In sharing information with buyers, the information needs to be complete, organized, and compiled in a manner that can be sliced and diced.

The value of a sell-side process is this information is fully vetted before a buy-side process starts.

2. Overextended employee resources

In smaller businesses, the accounting function likely wears many hats. There simply isn’t enough bandwidth to respond to buyer due diligence requests in a timely manner or in an organized fashion.

In a sell-side process, the service provider is an extension of the seller’s organization and can provide detailed information about financial trends, supporting schedules, etc., and present the information in the best possible light and in a format buy-side due diligence teams require.

3. Unclear financial narrative

Many sellers have deep knowledge about the intricacies of their businesses but struggle to articulate the financial information buyers are looking for succinctly and effectively. All buyers are looking to prove their investment theses during the due diligence process, and it’s paramount that sellers can speak to this.

A sell-side process can dig into this financial information and prepare the seller for these conversations.

4. Unhelpful “tax guy”

The seller’s trusted accounting advisor is often the external CPA (aka “my tax guy”). Unfortunately, tax CPAs generally aren’t able to speak to the company’s financial processes, accounting methodologies, and day-to-day bookkeeping. Additionally, they are generally not involved in the monthly closing and reporting of the financials. In short, they aren’t very helpful during a due diligence process and might do more harm than good with buyers.

By hiring a sell-side provider, sellers can ensure they’re prepared to speak comprehensively about the business’s financials — from  explaining subjective and estimated accruals to accounting for manufacturing variances to sharing  carve-out and standalone assumptions.

5. Multiple entities and no consolidation

As a seller’s business evolved, the seller might have started additional legal and financial entities, which are now being contemplated in a potential sale process. It’s likely that these entities have never been consolidated and intercompany transactions remain in the financial statements.

A sell-side process can determine the potential earnings impact of all the entities and provide a buyer with a consolidated view of what is being acquired.

6. Likely purchase price reductions

There are many findings that could lead to a purchase price reduction for the seller — accounting departures, non-recurring or out-of-period adjustments, inaccurate management-adjusted EBITDA, etc.

By conducting a sell-side process, sellers can get ahead of any potential risk areas that a buyer might identify and reduce the likelihood of re-trading after the letter of intent (LOI) has been signed and negotiating powers have shifted to the buyer.

7. Ineffective tax structuring

The majority of transactions are structured as stock or asset sales. Determining which tax structure is right for a seller can have a profound effect on the net cash realized by the seller.

The value of a sell-side process is a seller can minimize the impact of taxes on proceeds by strategically structuring deals to the seller’s best advantage (leading to more cash in the bank after close).

While no can predict whether a transaction will actually close, a sell-side due diligence process will significantly shorten the buyer due diligence period and reduce the chance of a broken deal. For sellers, hiring an advisor to assist with sell-side due diligence and business transition planning can ensure the M&A process will be as successful as possible.

Axial is the deal network for the middle market.

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