Due Diligence (DD) is a much mis-understood and often abused process.
It often leads to commercially sound deals falling over. The fallout includes a heavy financial cost and a high emotional toll on the business seller (and in many cases the buyer as well – as they will invested a lot of time and paid their own professional advisors).
For some savvy business buyers and their professional advisors Due Diligence is just another opportunity to re-negotiate whatever has already been agreed to date. They will use the Due Diligence process to corral and wear down the business seller. They then crunch the price or renegotiate others terms of the deal in favour of the buyer.
Often they do this with the almost complete (but subconscious) agreement of the business seller and their professional advisors.
I’ll explain how shortly.
Needless to say it doesn’t need to be that way.
If you understand why it happens then you can start to effectively prepare so that it doesn’t become a significant barrier to selling your business on your terms and in your timeframe.
So here a few reasons how and why it happens. Once you read through the list of reasons you’ll see how easily it can happen unwittingly or subconsciously;
- Poor drafting or definition of the DD clause. DD is a standard and very important part of any business sale agreement. BUT in many cases I have seen the DD clause is drafted so that in effect the buyer can do DD to their full satisfaction and at their discretion. In simple terms it’s a “get out of jail free card” that does not benefit you the seller in any way,
- Conventional thinking. There is a convention amongst many that DD is where the deal is really done.
- Most business sales are planned in an ad-hoc way with much more focus on getting quickly to market. As a result you can end up agreeing to an unstructured DD process on the basis that you think it will help to finally close the deal.
- Business sellers getting corralled into a deal feeling like they have little option left but to agree. After taking their business off the market on the basis of an offer the seller can end up dealing with a savvy business buyer who delays the process and uses a long-winded, open-ended DD to continually renegotiate
Poorly defined Due Diligence is the root cause of all these problems. It’s caused by a combination of relying on conventional, templated DD clauses and not putting enough time and effort into thinking about what DD should and shouldn’t be.
The best way to ensure DD doesn’t kill a potentially good deal for you is to;
1. Start the business sale planning process with a mindset that DD will be limited to and defined in a very tight way.
For example it might be limited to;
- Validation of what you make available during the process (meaning be sure that the information you share pre-DD is accurate), and
- Final checking of highly sensitive information (meaning, for example, that you disclose the names and contact details of key suppliers), and
- Limited to 5 working days (meaning it has an end date), and
- A review of a pre-agreed set of information (meaning the buyer can’t continually ask for extra, new or impossible to get information)
To be able to do this means you will have prepared a well-structured plan for filtering prospective buyers and progressively releasing credible, verifiable information about your business to potential buyers. I wrote about how to do this in detail in an earlier post http://wp.me/p38vL8-I
2. Think about and define what DD process you will agree to before you accept any offer.
As well-defined DD process and clause, as a minimum, will need to address;
- What information will be accessible,
- Where and how the information will be made available,
- The time-frame,
- How to quantify and/or define what successful DD is and isn’t,
- How disputed items will be dealt with.
Getting agreement with a buyer on what is and isn’t a fair & reasonable DD process for inclusion in their offer is a very effective way to filter out the tyre kickers. If they aren’t fair & reasonable it probably means one of two things – (1) they don’t really understand the mechanics of your business sufficiently yet or (2) they plan to play “hard ball” and renegotiate in DD.
Either way I advise you not to enter DD.
3. Ensure that your Lawyer drafts a DD clause to your satisfaction.
An effectively defined and well run DD process will;
- Increase the chances of getting a sale done (through entering DD only with buyers who really want your business and are using DD to validate or confirm what they have been told),
- Save time on dealing with tyre kickers (same reason as above),
- Save on professional advisory costs for the transaction (from not entering DD with a buyer who will extend the process and renegotiate and chew up your Lawyer and Accountant’s time),
- Preserve the confidentiality of your commercially sensitive business information.
At the start of any business sale process there are many things to focus on.
So DD might seem like something that can be put off until later.
It’s one of the biggest causes of deals falling over so give it some thought early on.
From personal experience the impact on a business seller who finally thinks they have sold their business only to have it fall over in a badly designed DD is absolutely crushing.
Recovering from a rollercoaster ride – the absolute high (we’ve finally sold) to the absolute low (when it falls over) – is very, very hard.
You would soon realise that because the business has been off the market the other potential buyers have long disappeared. You’ll soon see that re-starting the whole business sale process, from scratch, is much harder than it was the first time.
While DD will never be a simple formality you’re much better not getting into DD unless;
- You really are confident that the buyer understands your business, is genuine and wants to buy, and
- That you feel like the business stack up in DD against the process and measures of success you have defined.
Until next time,