The most crucial stage in the process of buying a business is when the formal due diligence phase begins. This is the time when the parties have come to an agreement and the buyer will have a certain period in which to investigate the business and, if necessary, rescind their offer if they determine the business does not meet their criteria.
While there are a wide array of parameters to establishing the due diligence period which could last anywhere from a few days until the actual closing, there are, nevertheless, some common issues that all parties need to consider which will be discussed over the next few blog/newsletter posts.
Today, I want to discuss the following:
- When due diligence begins
- The buyers agenda
- Basic protections for the buyer
When does the due diligence period begin?
As mentioned above, the “formal” due diligence phase starts once an agreement is executed by the buyer and seller. However, one must set aside the “formal” phase and realize that the due diligence of a business begins the moment it is of interest to the buyer. Since there is a limited time frame allocated in an agreement for a buyer to have full access to the company and its records, a prudent buyer understands that the investigation of the industry, competition and the preliminary financials have to get underway earlier. While many areas can only be reviewed once full access is available, certainly the initial investigation can begin.
It is estimated that fifty percent of all deals that enter the formal due diligence stage never make it to the closing table. This has always been a staggering and disturbing statistic to me but not at all surprising. There are a number of reasons for this dismal statistic, but the common denominator is the end of the period arrived and there was too much uncertainty for the buyer to move forward and close the deal. One key ingredient that leads to this is the buyer's lack of preparation to complete an exhaustive review in the period allocated. Had they addressed these issues from the beginning as I have discussed, often times those unresolved issues could be satisfied and the uncertainly eliminated or diminished.
What should the buyer’s agenda be?
Some buyers go into due diligence looking for problems with the express hope of being able to renegotiate the deal. This is the wrong strategy. Due diligence is the time for a buyer to reconfirm everything that has been represented by the seller and to validate that the business is worth purchasing. Obviously, it is paramount that any and all problems be uncovered including misrepresentations and potential looming threats that could hurt the business after a new owner takes over. That is why it is critically important that a buyer goes through all areas of the business with a fine-tooth comb.
Basic protections a buyer should have in place
A buyer needs to be certain they are not locked into any obligations through to the end of the due diligence period. This means they (the buyer) can, at any time during this period, rescind their offer for any reason (or no reason), and not have any obligation whatsoever to the seller, financial or otherwise.
One clause I have seen in contracts is where the buyer is deemed to have accepted the due diligence period if the company revenues/profits are within a certain percentage of what was initially represented. Well, what if indeed this is the case, but the seller discovers that one client represents 80 percent of the sales, or the company just lost a major customer, or its lease won’t be renewed, or a major supplier won’t supply a new owner, or there is a multi-year major road construction project being planned for the main access way to the business and all traffic will be re-routed? The potential issues that could influence a buyer to not to proceed with a deal are endless so it does not make any sense to be locked into anything until the period is over and the buyer can make a prudent decision either way.
Due diligence is the buyer’s period. It is their time to complete the tangible analysis and also reconcile the psychological factors. In other words, it is an exercise of both logic and emotion. Proper preparation is key, but diligence, as the name suggests, in addressing all aspects of the business, is what will allow the buyer to complete their review effectively and ultimately, if the future sustainability of the business can be validated, the deal will, in most cases, get to the closing table.
Next edition we will discuss how to separate minor issues from major ones, what if a buyer has to renegotiate the deal based upon their findings and how to conduct a thorough review given the concernss every seller has about due diligence.
Have a great week.
Diomo.com – The Business Buyer Resource Center™