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Using sell-side due diligence to prepare your company for a sale

My mother was an educator and had a lot of good advice for me when I was growing up. I asked her once, "When do you think I should start studying for final exams?" Her reply was, "The first day of class." That logic can also be applied to your business. You should start thinking about your exit strategy when you write your business plan. That exit strategy may be different for each person starting a business. One may want to pass the business on to their children; another may want to sell the business to the employees; and yet another may want to sell to a third party and pocket the cash. I had a client tell me one time that his exit strategy was feet first. Not a good idea. 

With the current economic climate, many companies either need to find a buyer or want to prepare to sell when their industry's market makes an upturn. How does a company prepare for a sell event so that they are rewarded with the highest price for their company? One way to prepare now is to perform a sell-side due diligence review. This process is designed to allow current management to continue to focus on day-to-day operations while outside professionals perform agreed upon procedures on your accounting and operations records and reports.  

Are Your Financial Reports in Order?

To sell your company at the best possible price, considering the current market conditions, you have to have the financial records in a condition that potential buyers can quickly understand key financial information and operations reports. Accuracy and transparency are key as buyers are evaluating your company and preparing an offer.

Potential buyers want to ensure the quality of their purchases and develop a business plan and financial model that produces a significant return on their investment. Those goals can only be achieved by quality due diligence to understand the company the buyer is purchasing and then integrating that purchase into their current organization. Most buyers will not be satisfied with a company's internally prepared financial reports and will perform their own extensive due diligence or hire a CPA firm to assist them in a buy-side due diligence effort. 

Any undisclosed financial issues or non-GAAP accounting treatment that arise during due diligence by the potential buyer of your business will give rise to credibility issues from the potential buyer's viewpoint regarding the seller. Furthermore, the buyer will consider this an increase in their risk factor for buying the company. 

Transparency: The Key to Sell-side Due Diligence

In order to mitigate this potential credibility and risk issue as much as possible, you should consider performing a full scope sell-side due diligence engagement. This review is designed to uncover potential concerns or anomalies that you will either want to correct or make the buyer aware of during the initial discussions. This transparency with the buyer will allow you to get the best possible purchase price for your business, shorten the purchase process and improve your credibility with the potential buyer. 

Sell-side due diligence is a cost-effective approach to dealing with issues up front and providing the transparency that potential buyers appreciate. Credibility of the seller's financial and operations team can significantly impact (negatively and positively) the negotiations and final price.

Areas to Review

The key areas of review in a sell-side due diligence:

  • Last Twelve Months (LTM) Earnings Before Interest, Taxes, Depreciation and Amortization (EBITDA)
  • Backlogs
  • Quality of Earnings
  • Sales / Revenue
  • Gross Margins
  • Accounts Receivable and Bad Debts
  • Accounts Payable and Purchasing
  • Inventories
  • Compensation and Bonuses / Staff Levels
  • Ability of the company to extract information such as profitability by product, customer, division, region, etc.
  • Non-recurring and infrequent transactions such as extraordinary professional fees, severance costs, inventory write-offs, and unusual bad debts
  • Evaluation of the management team

Potential Benefits of Sell-side Due Diligence

By performing a complete sell-side due diligence review, you may see benefits such as:

  • Increased credibility of seller's management team
  • Transparency of financial transactions
  • Having records in proper order
  • Lack of surprises during buyer's due diligence
  • Prepared data room for buyer's due diligence
  • Accelerated closing
  • Higher sales price

A sell-side due diligence engagement can provide you with the confidence needed to properly market the company and feel assured the financial records and marketing documents provide an accurate and transparent picture of the company. This allows you to be ready when a buyer approaches the company and provides them with the assurances they need to drive the best deal for the shareholders of the firm.

If your exit strategy is something other than feet first, consider a sell-side due diligence engagement to find out what you need to do to get your company ready for a willing buyer. Because when it comes to willing buyers you never know when they may be knocking at your door.

Byron Hebert, CPA, CTP, is the director of Entrepreneurial Advisory Services for PKF Texas. PKF Texas can provide assistance to companies looking to implement the techniques detailed in this issue.