What are some of the best practices to adopt when conducting due diligence during a business acquisition?
In order to be successful with your due diligence efforts, there is a need for a strategic plan of action and a team of experienced professionals. The process of carefully appraising a business prior to purchase in order to establish assets and liabilities, as well as evaluate the company’s potential cannot be done haphazardly.
That’s why M&A expert, Domenic Rinaldi, has put together this tactical due diligence guide complete with an actionable checklist to ensure you’ve got all your bases covered.
In this post, you’ll learn Domenic’s top 10 due diligence best practices and get a bonus checklist to help you tackle this process efficiently.
Due Diligence Best Practice #1 Begin with a clear LOI
Your Letter of Intent (LOI) should be as elaborate as possible. It will act as the anchor, framework, and guide for all ensuing negotiations and due diligence procedures.
An experienced M&A attorney should draft the LOI as they will pay special attention to issues needing to be explored during the due diligence process as well as those to be faced in the post-closing stage.
Summary: “An LOI will set the table for the diligence process and ensure that things can move smoothly, on time, and that you’ll have unfettered access to all the information that you need so that you can get through the process as quickly as possible with the least amount of disruption to the company and yourself.”
Due Diligence Best Practice #2 Surround yourself with good advisors
Mergers and acquisitions are complex. However, a proficient team of M&A advisors will help you avoid the numerous pitfalls that surround business acquisitions.
By leveraging the skills and experience of your consultants you can spot bad deals quicker, negotiate with more confidence, and close at a price that you’re happy with.
Summary: “There’s probably no one more important thing that I can recommend to you than surrounding yourself with good M&A advisors, a great M&A attorney, a great M&A accountant, M&A intermediaries like ourselves, and people who understand M&A and can guide you through the process.”
Due Diligence Best Practice #3 Start due diligence yourself
Before you bring in your advisors, it’s wise to begin the due diligence process yourself. This gives you the freedom to explore areas of the business that you are particularly interested in.
Once you’re satisfied with your own efforts, you can then bring in professionals. Review the financials and operations with them to ensure nothing was missed.
Summary: “It doesn’t cost you any money to do it yourself, and you might find some things that are material or substantial that you might want to get understood and explained by the seller before you start to spend lots of money on advisors.”
Due Diligence Best Practice #4 Be curious about the company
Is there something that’s not clear that you’d like clarified? Are there things that concern you about the target business?
Due diligence is the time to delve deeper into company culture, operations, and processes. By asking questions and listening to the answers you will begin to discover the weaknesses in the business.
Summary: “Vet everything carefully. Ask as many questions as necessary. When you ask a question and don’t get the answer to that question, keep asking it. Maybe you need to ask it in different ways but you should be curious.”
Due Diligence Best Practice #5 Use secure data rooms for communication
What mediums are you using for communicating with the seller? Email isn’t as reliable as people would like to believe. That’s why data rooms are the next best thing.
They provide a secure platform to exchange sensitive information such as financials and ensure everything is kept in a centralized repository.
Summary: “Oftentimes, people will enter diligence and will email exchange with an owner. This is not a best practice on how to conduct due diligence. The best practice here is to manage a data room.”
Due Diligence Best Practice #6 Have a plan to get to know the people in the target company
The talent you’re acquiring is the most important asset in this business acquisition. They are the heart and soul of the company. Without them, operations will screech to a grinding halt.
That’s why it’s critical to have a plan pertaining specifically to the employees outlining how you’re going to strategically get a feel of the work they do and their unique responsibilities.
Summary: “There is no more valuable asset that you are acquiring than the people in a business. You need to have a plan to understand how the people operate, how they do their jobs, how they’re incented, what the culture of the business is.”
Due Diligence Best Practice #7 Approach several lenders
Approach several lenders during the due diligence phase. Doing this allows you to receive different quotations for lending packages.
Having a handful of lenders forces them to be competitive and offer you attractive working capital lines. Options are always welcome when it comes to financing the deal.
Summary: “It’s important that you line up multiple lenders. Send them the packages so that they can vet the business, and come back with a loan package for you so you can look and see which ones make the most sense for you.”
Due Diligence Best Practice #8 Develop an integration and communication plan
Waiting until the last minute to piece together an integration plan is a recipe for disaster. A communication and integration game plan must be developed early enough so that you hit the ground running on Day 1.
This plan should factor in how you will inform employees, clients, and partners of the business acquisition and change in ownership.
Additionally, if you have changes you want to implement in the business in the future, discuss these with the seller and get their feedback so you can properly refine your integration and communication plan.
Summary: “Due diligence is the exact time to be building what the integration and communication to all the constituents in a transaction is going to look like.”
Due Diligence Best Practice #9 Define your investment expectations
Business acquisition is an investment and as such you should be interested in gauging the return on your investment. In other words, how much do you expect to make for every dollar invested?
It’s good to have an expectation. Where do you see the business in one or two years’ time? How profitable do you hope it to be?
Summary: “Your investment should have a goal line. What are you trying to achieve? What return on investment are you looking for?”
Due Diligence Best Practice #10 Prepare for a tumultuous ride
Anticipate speed bumps and pitfalls during the due diligence process. As you peel back the layers surrounding the business to expose what lies beneath, you’re bound to find a few shocking things.
However, the key is deciphering whether the issues can be resolved or they are deal-breakers. There are some difficulties that your M&A advisors can help you through and then there are those that negate the deal.
Be prepared to tackle and face all kinds of issues during due diligence.
Summary: “I have yet to see a smooth deal go through from beginning to end without issues popping up. You are going to hit issues. Expect a bumpy ride in diligence, as well as post-transaction.”
Now, as promised, here is the checklist or rundown of the things to keep an eye out for.
Checklist Item #1 Organization patient: Check the organization’s business certifications and licenses of operations and make sure they are up-to-date.
Checklist Item #2 Financial records: Get your hands on all the financials including balance sheets, bank and credit card statements, P&Ls, tax returns, projections, liabilities, and account receivables.
Checklist Item #3 Company assets: Obtain a copy of all the business’ assets including assets that will be exempted from the business acquisition.
Checklist Item #4 Employee benefits: Learn all you can about the employees. Their compensation packages, benefits, claims, terminations, and any issues lodged with HR over the years.
Checklist Item #5 Growth prospects: Where is the business headed? What does the market look like? What growth opportunities lie ahead? How can you take more market share?
Checklist Item #6 Sales and marketing: How does the company conduct its marketing? How much is spent on marketing campaigns? What are the most successful marketing channels? Who are the main clients/the retainers/the repeat buyers?
Checklist Item #7 Competitors: Who dominates the industry? What distinguishes them from the rest? Where does the target business lie within the industry?
Checklist Item #8 Leases: Secure copies of all the leases and understand what your commitment to the property leases will be.
Checklist Item #9 Material contracts: Ensure you review client and vendor contracts. Any and all amendments must be carefully noted. Verify what happens in the case of a change in business ownership.
Checklist Item #10 Legal review: Are there any pending lawsuits against the business? What is the target business’ history with litigation? Obtain a list of the previous lawyers and consulting firms the company’s worked with.
Checklist Item #11 Operational processes: Secure the company process and operations manuals and list of operational vendors.
Checklist Item #12 Technology and security: What technology is used and how is data secured across the enterprise network?
While due diligence is a seemingly convoluted process it doesn’t have to be difficult. Armed with the right strategies and help from experienced professionals, things can go relatively smoothly.
Also, remember that good communication between the buyer and the seller cannot be underestimated. If you wish to have a straightforward due diligence process don’t forget to work on fostering good rapport. It will make the work easier for yourself and your M&A advisory team.
If you’re thinking of an M&A and need to discuss your options with an expert, don’t hesitate to contact us.