M&A due diligence is a crucial phase in the mergers & acquisitions process. In due diligence, the buyer will investigate a company’s finances, business operations, and legal compliance to identify risk and determine whether the price point is reasonable.
For sellers, due diligence is the most daunting phase of the M&A process. You’ve made a great effort to grow your company, maintain efficient business operations, and keep meticulous records; it’s challenging to have another business owner or private equity group inspect every last detail of your company, rigorously searching for flaws and discrepancies.
However, due diligence is a great opportunity to strengthen your terms of sale. With the right preparedness, you can defend or even increase your asking price by strategically organizing and presenting your company information.
It’s always best to consult with M&A advisors when you’re selling your business. M&A transactions are highly complex, so receiving guidance through each step in the process will ensure your sale has a favorable outcome and help you accomplish your sales objectives.
About Walden
Walden is a leading mergers and acquisitions (M&A) firm based in Atlanta, Georgia. Led by a team of business owners with experience selling their own companies, Walden has closed numerous multi-million dollar transactions for business owners, buyers, and investors.
What is Due Diligence in M&A?
Buyers perform a “due diligence” investigation to assess the financial health, operational efficiency, and legal compliance of a company they’re going to purchase. It’s a critical step in the mergers and acquisitions (M&A) process, as it helps buyers make informed decisions and identify potential risks.
“Historically, only the buyer performed due diligence. They would run the analysis, locate problems, and restate the financials to reflect the errors they found. That usually results in a loss of sales price.
-John S. Phillips, President and CEO, Walden
Now, the seller also performs due diligence. They run their own analysis of their company, finding and cleaning up problems before the buyer enters the process. It puts the seller in a better negotiating position and greatly reduces renegotiation.”
Due Diligence for the Buyer
Buyers want to make sure the company they’re purchasing has a viable business model, so they will evaluate your company’s financials and make sure the value is appropriate based on your revenue, expenses, debt, market position, and projected growth.
The buyer will evaluate other aspects of your business, too, including your operations, legal compliance, and IT systems. They want to make sure your business has no major problems which could hinder its performance or profitability in the future.
Learn More: Buy-Side Diligence
Due Diligence for the Seller
Due diligence is often very uncomfortable for the seller. It’s challenging to have your books, sensitive documents, and business operations thoroughly examined and questioned by a stranger. It’s natural to feel this way, and we have yet to work with a business owner who doesn’t feel some amount of trepidation about this phase of the transaction. Remember that due diligence is a normal part of the M&A process and you have nothing to be concerned about if you’ve run your business with integrity.
You can make this process easier by performing your own audit, known as sell-side due diligence.
Sell-side due diligence is when you evaluate your own company in the same way a buyer would. By running your own analysis of your business, you can make sure you’re pricing your company as high as possible. It also prepares you for the inevitable questions and talking points that arise during negotiations.
Most buyers will look for reasons to negotiate down the price of the target company. The best way for sellers to defend their sales price is to be proactive in analyzing their own finances and business operations, enabling them to spot and resolve issues in advance.
“Due diligence is not only for the buyer. We guide sellers through their own due diligence, helping them identify and resolve issues that could potentially harm the outcome of the sale. This is crucial for hastening the M&A process and helping business owners defend their company’s price point.”
-Dean McDonald, Principal, Walden
Learn More: Sell-Side Due Diligence
What to Expect from the Due Diligence Process
M&A due diligence is a complicated process that varies with each transaction. Generally, you can expect due diligence to cover the following areas:
- Financial Due Diligence
- Tax Due Diligence
- Operational Due Diligence
- Legal Due Diligence
- IT Due Diligence
- Cultural Due Diligence
1. Financial Due Diligence
Financial due diligence involves a thorough examination of your company’s financial health. Key areas of focus include:
- Financial Statements: Analyzing income statements, balance sheets, and cash flow statements to assess your company’s financial performance.
- Accounting Practices: Evaluating your company’s accounting policies and procedures to ensure compliance with relevant standards.
- Tax Returns: Reviewing your company’s tax filings to identify potential tax liabilities and compliance issues.
- Working Capital: Assessing your company’s working capital and identifying potential shortfalls.
2. Tax Due Diligence
The buyer will review your company’s tax compliance and identify potential tax liabilities. Key areas of focus include:
- Tax Returns: Analyzing historical tax returns to identify any potential tax issues or discrepancies.
- Tax Planning Strategies: Evaluating your company’s tax planning strategies to identify any opportunities for optimization.
- Transfer Pricing: Assessing your company’s transfer pricing policies and documentation to ensure compliance with tax regulations.
3. Operational Due Diligence
The buyer will evaluate your company’s operational efficiency and business processes. Key areas of focus include:
- Business Model: Assessing your company’s business model, revenue streams, and customer base.
- Management Team: Evaluating the experience, skills, and capabilities of your management team.
- Operational Processes: Reviewing your company’s operational processes and identifying opportunities for improvement.
- Supply Chain: Assessing your company’s supply chain, including suppliers, distributors, and logistics.
4. Legal Due Diligence
The buyer will review your company’s legal and regulatory compliance. Key areas of focus include:
- Contracts: Reviewing contracts with customers, suppliers, and partners to identify potential liabilities.
- Intellectual Property: Assessing your company’s intellectual property rights, including patents, trademarks, and copyrights.
- Regulatory Compliance: Evaluating your company’s compliance with relevant laws and regulations.
- Litigation: Identifying pending or potential litigation that could impact the company.
5. Information Technology (IT) Due Diligence
The buyer will evaluate your company’s IT infrastructure, systems, and data security. Key areas of focus include:
- IT Infrastructure: Assessing your company’s hardware, software, and network infrastructure.
- Data Security: Evaluating your company’s data security practices, including data protection and cybersecurity measures.
- IT Systems: Reviewing your company’s IT systems, including ERP systems, CRM systems, and other software applications.
6. Cultural Due Diligence
In cultural due diligence (also known as strategic due diligence) the buyer will assess the cultural compatibility between your two companies. Key areas of focus include:
- Corporate Culture: Evaluating the company’s corporate culture, values, and mission.
- Management Style: Assessing the management style and leadership approach of the target company.
There are two reasons why cultural due diligence is important.
First, continuity of leadership is a critical factor in most M&A transactions. It’s common for the former owner to continue working for the company for a period of time after the sale to ensure a smooth and effective ownership transition. Problems arise when the new owner and former owner have drastically different leadership styles.
Second, sellers want to make sure the buyer is truly interested in and committed to closing a deal. Because M&A transactions are time-consuming and complex, buyers need to have strong financial or personal reasoning for acquiring the company. Likewise, sellers often have an emotional attachment to their company and may turn away from a deal if the buyer has an imprudent attitude.
At Walden, we do cultural due diligence much earlier in the M&A process. We search for buyers who:
- Have a strong interest in entering your company’s market space
- Share your approach to business and leadership
- Are able to work with your initial sales terms and have financial backing to make the purchase
We do not bring buyers into the M&A process until we’re certain they’re a strong strategic fit.
“One of the most important aspects of the M&A process is finding the right buyer. The due diligence process involves a significant back-and-forth between the buyer and seller, so the buyer needs to be committed to entering your market space and have a positive attitude about working with you to overcome misunderstandings and disagreements. Our team at Walden looks for buyers who have these qualities.”
-Sara Burden, Principal, Walden
Challenges in the Due Diligence Process
Due diligence can present several challenges for those who are selling their business:
- Time Constraints: Due diligence often has tight deadlines, which can make it difficult for you to gather and analyze all necessary information, especially when you’re preoccupied with running your business.
- Access to Information: You might feel reluctant to share sensitive information about your business.
- Defending Your Value: Some accounting problems and discrepancies could lower the valuation of your company. Due diligence will help you identify and mitigate these problems ahead of time.
- Confidentiality: Companies need to maintain confidentiality during the M&A process to preserve employee morale and keep competitors from gaining an edge. It can be challenging to balance confidentiality with the need for transparency.
“A significant challenge in due diligence is when the seller isn’t responsive to the buyer. The buyer will ask for certain information, and the seller doesn’t quickly provide that information because they’re not sure how to gather it. This can prolong the due diligence process and put the transaction at a higher risk of failure. At Walden, we help business owners prepare all the information they need for due diligence well beforehand and prepare them for the questions they will be asked.”
-John S. Phillips, President and CEO, Walden
Prepare Your Business for M&A Due Diligence
You can successfully navigate M&A due diligence by enlisting Walden. Our M&A firm is led by former business owners who understand what you have at stake in selling your business.
Through our fine-tuned approach to the M&A process, we’ll help you prepare for due diligence, connect you with the right buyer, and guide you through each step of the transaction so you can stay focused on running your company and keeping it profitable.
Contact us today to get started or learn more about our advisors.
