As you can see from these numbers, very few transactions are completed and only one in four or five transactions were being completed after having an agreement in place. Further studies revealed that these companies, in which letters of intent had been agreed to, failed due diligence from the buyer's perspective.
So what is due diligence? It is similar to having a forensic analysis done on all the company's various activities. For example, a printing company's analysis would include – but not be limited to – the following: financial reports; the business's market and its position in the market; marketing and advertising programs; sales and distribution methods; manufacturing processes; the company's technological position in the industry; and the company's customers.
Large acquirers take this process seriously and will abort any transaction that does not meet its requirements.
Why do so many companies fail due diligence? Failing may not be the appropriate term; meeting expectations of the purchaser may be more appropriate. Understanding the process is the first step to understanding the problem. Many companies set strategic goals that may include making an acquisition. Knowing that they will review hundreds of opportunities before finding an “ideal fit”, they will send out the word far and wide.
As a result, they uncover many potential candidates who have not properly prepared their business for a sale. The result is limited information to determine values, prepare a letter of intent and complete their due diligence. The original acquisition criteria may be vague. Once the letter of intent is agreed to, the acquirer then starts thinking about the strategic goals for the business, and will try to fit the target company into that vision.
The result is a buyer trying to complete a transaction without clearly defined goals and objectives; and an owner who has not prepared his company for sale (but does not want to miss the opportunity of a lifetime).
Due diligence should be done before a business goes to market. A professional will prepare a data book or profile containing information that any qualified purchaser would require to assess the business. The buyers need to be qualified as to their 3 M's (money, management and motivation) before any information is provided.
A potential client received an unsolicited offer for $1.1 million that he was seriously considering when he asked us to give him a second opinion. The book value of the company was $1.1 million, contained the usual assets and liabilities, plus $600,000 in cash. The shareholder's discretionary cash flow was $600,000 per year. The offer was $500,000 in cash down, a note for $600,000 paid over three years and the client had to sign a three-year employment agreement to operate the business for the buyer. The true value of the business was about $1.8 million after the cash was removed.
Had this owner taken the time at the beginning of this process to learn the true value of his business, he would not have wasted his time with this proposal. Fortunately, he decided to ask for a second opinion before he sold the business.
Anyone thinking of selling their business should take the time to do it right and have a professional take the company through a due diligence process to determine what value the company might be to a prospective purchaser. This would remove any obstacles or impediments to the sale of the company prior to going to market and to determine any value enhancement that could have a significant impact on the value of the company. The professional should then structure the sale of the company in a manner to yield the highest after-tax dollars to the seller.
The bottom line is: “If something is worth doing, take the time to do it right”.
