The process of selling a business is filled with peaks, valleys and “plateau moments.” One of the inevitable, but necessary challenges that sellers must confront during the sale process is the buyer’s due diligence phase. This occurs during Phase IV, or the final stage of the sale process. As we have discussed previously, this stage of the sale process can be long and tedious due to the volume of information that must be provided to the buyer. The preparation and submission of diligence materials can arguably include thousands of pages of documents on the company, including corporate organization, financial and tax, customer, vendor, contracts, employees, benefits plans, insurance, IT, environmental, etc. Before the buyer can begin their due diligence on these topics, the seller must provide all of this information to the buyer. It is when those diligence requests from the buyer start rolling in that the seller and their team will often do what we like to call “the diligence groan.”
Picture this: the seller has hit a plateau moment in the sale process. The seller and their team have completed the management presentation phase and subsequently negotiated and executed a Letter of Intent (“LOI”) with one buyer. Immediately after executing the LOI, the seller hits a plateau moment, where they can pause to breathe ever so briefly. Then, reality hits. The buyer’s diligence requests start rolling in, fast and furious. And those requests can sometimes be a hefty 40 or more pages long.
Even the most prepared sellers who have been preparing their business for sale for months or years may feel overwhelmed, bogged down and stressed by the sheer magnitude of the buyer’s diligence requests and the requirement to answer their inquiries for information. From the seller’s point of view, slogging through these requests and answering all of the buyer’s questions down to the most granular level may seem tedious and arduous, even eliciting an actual, audible groan from the seller when they think about how much work is ahead of them. Nonetheless, fulfilling the buyer’s diligence requests is a critical step in the sale process, and not one sellers should take lightly. In addition, the results of the diligence will strongly influence the terms of the (asset or stock) purchase agreement and will be instrumental in efficiently preparing the purchase agreement schedules.
So after getting the initial “diligence groan” (or several) out of the way, how should sellers proceed to effectively tackle the buyer’s requests? It is like that old saying: “How do you eat an elephant? Bite by bite.” The same concept applies to the seller when taking on the buyer’s diligence requests. For starters, sellers should understand that completing the buyer’s diligence requests requires a serious time commitment. Typically, it may take the seller and their team several weeks or more to get through the buyer’s initial diligence requests, all while running their company. This is one of the reasons that, for the owner, selling their company is a second job.
In our experience, there is a natural progression to the diligence process. Accounting and QoE due diligence represent the first requests from the buyer; legal diligence will closely follow the accounting and QoE diligence requests; human resources, benefits, information technology (“IT”), environmental, etc. will all follow, the order of which will depend on the importance and/or perceived areas of risk in the transaction. Answering all of these requests in a way that is satisfactory to the buyer requires patience, time and careful attention to detail on the part of the seller and their team. And even then, it is inevitable that the buyer will have follow-up questions and additional requests. It is important to note that before accumulating any of the diligence information, the buyer and seller should step through each diligence request to clarify the request, identify N/A items, and prioritize the responses. In addition, each diligence request should also be individually prioritized. For example, accounting and legal should take priority over human resources, IT, etc. Based on the transaction, the buyer and seller should agree on the natural priority of diligence requests.
As sellers develop a strategy to respond to the information requests, they should consider starting with the easy items first, such as questions that require only the printing or attaching of a pre-existing file. Accounting and internally prepared financial statements are examples of information that is easy to provide. Stacking up these “small wins” early on can help a seller feel good about the progress they are making in responding to the buyer’s diligence requests. Bonus: starting with the easiest questions is a win-win for both the buyer and the seller because it appears to the buyer that the seller is responding timely to their requests, and again, the seller can feel good psychologically about completing at least a portion of the request before diving into the more time-consuming, nitty-gritty items — usually the culprit behind the “diligence groan.” During this phase, maintaining momentum in the deal by providing a strong flow of information to the buyer is crucial. Failure to provide a flow of information to the buyer may suggest that the sale of the company is not a priority for the owner or that the seller has another agenda. Additionally, sellers should consult with their advisors early and often for support during the buyer diligence phase.
Sellers can make the diligence process and the transmission of information easier for everyone involved in the deal by establishing a virtual data room (“VDR”) to house all of the important documents relevant to the deal. A VDR is a secure online portal where critical company documents are stored. Widely used in M&A transactions to help facilitate due diligence, VDRs make it easier for buyers and their team of advisors to access information provided by the seller without having to travel to a physical location. VDRs can also send alerts to the buyer every time new information is uploaded.
While the buyer due diligence phase is certainly one of the more challenging stages of a transaction, sellers should keep in mind, it is a means to an end. It is okay, even normal, for sellers to do the “diligence groan” when the diligence phase of the sale process begins and then feels endless. And until the closing, the buyer or someone from their team is always going to be asking the seller “just one more question.” With that said though, the seller must dig deep and do the hard work to get the company sold in a timely and efficient manner. We advise sellers to keep their eyes on the prize: the successful sale of their company that achieves their objectives.
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