The Letter of Intent has been signed by both buyer and seller and everything seems to be moving along just fine. It would seem that the deal is almost done. However, the due diligence process must now be completed. Due diligence is the process in which the buyer really decides to go forward with the deal, or, depending on what is discovered, to renegotiate the price – or even to withdraw from the deal. So, the deal may seem to be almost done, but it really isn’t – yet!
It is important that both sides to the transaction understand just what is going to take place in the due diligence process. The importance of the due diligence process cannot be underestimated. Stanley Foster Reed in his book, The Art of M&A, wrote, “The basic function of due diligence is to assess the benefits and liabilities of a proposed acquisition by inquiring into all relevant aspects of the past, present, and predictable future of the business to be purchased.”
Prior to the due diligence process, buyers should assemble their experts to assist in this phase. These might include appraisers, accountants, lawyers, environmental experts, marketing personnel, etc. Many buyers fail to add an operational person familiar with the type of business under consideration. The legal and accounting side may be fine, but a good fix on the operations themselves is very important as a part of the due diligence process. After all, this is what the buyer is really buying.
Since the due diligence phase does involve both buyer and seller, here is a brief checklist of some of the main items for both parties to consider.
Figure the percentage of sales by product line, review pricing policies, consider discount structure and product warranties; and if possible check against industry guidelines.
Review names, positions and responsibilities of the key management staff. Also, check the relationships, if appropriate, with labor, employee turnover, and incentive and bonus arrangements.
Get a list of the major customers and arrive at a sales breakdown by region, and country, if exporting. Compare the company’s market share to the competition, if possible.
Review the current financial statements and compare to the budget. Check the incoming sales, analyze the backlog and the prospects for future sales.
Accounts receivables should be checked for aging, who’s paying and who isn’t, bad debt and the reserves. Inventory should be checked for work-in-process, finished goods along with turnover, non-usable inventory and the policy for returns and/or write-offs.
This is a new but quite complicated process. Ground contamination, ground water, lead paint and asbestos issues are all reasons for deals not closing, or at best not closing in a timely manner.
This is where an operational expert can be invaluable. Does the facility work efficiently? How old and serviceable is the machinery and equipment? Is the technology still current? What is it really worth? Other areas, such as the manufacturing time by product, outsourcing in place, key suppliers – all of these should be checked.
Trademarks, Patents & Copyrights
Are these intangible assets transferable, and whose name are they in. If they are in an individual name – can they be transferred to the buyer? In today’s business world where intangible assets may be the backbone of the company, the deal is generally based on the satisfactory transfer of these assets.
Due diligence can determine whether the buyer goes through with the deal or begins a new round of negotiations. By completing the due diligence process, the buyer process insures, as far as possible, that the buyer is getting what he or she bargained for. The executed Letter of Intent is, in many ways, just the beginning.
Buying a Business – Some Key Consideration
- What’s for sale? What’s not for sale? Is real estate included? Is some of the machinery and/or equipment leased?
- Is there anything proprietary such as patents, copyrights or trademarks?
- Are there any barriers of entry? Is it capital, labor, intellectual property, personal relationships, location – or what?
- What is the company’s competitive advantage – special niche, great marketing, state-of-the-art manufacturing capability, well-known brands, etc.?
- Are there any assets not generating income and can they be sold?
- Are agreements in place with key employees and if not – why not?
- How can the business grow? Or, can it grow?
- Is the business dependent on the owner? Is there any depth to the management team?
- How is the financial reporting handled? Is it sufficient for the business? How does management utilize it?
According to the experts, a business owner should lay the groundwork for selling at about the same time as he or she first opens the door for business. Great advice, but it rarely happens. Most sales of businesses are event-driven; i.e., an event or circumstance such as partnership problems, divorce, health, or just plain burn-out pushes the business owner into selling. The business owner now becomes a seller without considering the unexpected issues that almost always occur. Here are some questions that need answering before selling:
How much is your time worth?
Business owners have a business to run, and they are generally the mainstay of the operation. If they are too busy trying to meet with prospective buyers, answering their questions and getting necessary data to them, the business may play second fiddle. Buyers can be very demanding and ignoring them may not only kill a possible sale, but will also reduce the purchase price. Using the services of a business broker is a great time saver. In addition to all of the other duties they will handle, they will make sure that the owners meet only with qualified prospects and at a time convenient for the owner.
How involved do you need to be?
Some business owners feel that they need to know every detail of a buyer’s visit to the business. They want to be involved in this, and in every other detail of the process. This takes away from running the business. Owners must realize that prospective buyers assume that the business will continue to run successfully during the sales process and through the closing. Micromanaging the sales process takes time from the business. This is another reason to use the services of a business broker. They can handle the details of the selling process, and they will keep sellers informed every step of the way – leaving the owner with the time necessary to run the business. However, they are well aware that it is the seller’s business and that the seller makes the decisions.
Are there any other decision makers?
Sellers sometimes forget that they have a silent partner, or that they put their spouse’s name on the liquor license, or that they sold some stock to their brother-in-law in exchange for some operating capital. These part-owners might very well come out of the woodwork and create issues that can thwart a sale. A silent partner ceases to be silent and expects a much bigger slice of the pie than the seller is willing to give. The answer is for the seller to gather approvals of all the parties in writing prior to going to market.
How important is confidentiality?
This is always an important issue. Leaks can occur. The more active the selling process (which benefits the seller and greatly increases the chance of a higher price), the more likely the word will get out. Sellers should have a back-up plan in case confidentiality is breached. Business brokers are experienced in maintaining confidentiality and can be a big help in this area.
It’s always nice, when eating at a nice restaurant, for the owner to come up and ask how everything was. That personal contact goes a long way in keeping customers happy – and returning. It seems that customer service is now handled by making a potential customer or client wait on a telephone for what seems like forever, often forcing them to repeatedly listen to a recording saying that the call will be handled in 10 minutes. Small businesses are usually built around personal customer service. If you are a business owner, when is the last time you “worked the floor” or handled the phone, or had lunch with a good customer? Customers and clients like to do business with the owner. Even a friendly “hello” or “nice to see you again” goes a long way in customer relations and service.
The importance of knowing your customers and/or clients could actually be extended to suppliers, vendors, and others connected with your business. When is the last time you visited with your banker, accountant, or legal advisor? A friendly call to your biggest supplier(s) can go a long way in building relationships. A call to one of these people thanking them for prompt delivery can pay big dividends if and when a problem really develops. With most communication now done online, a handwritten thank you to a long-standing customer, someone whose recommendation resulted in a new customer, or a vendor you appreciate stands out among the bills and junk mail.
Owning and operating your own business is not a “backroom” or “hide behind the business plan” business. It is a “front-room” business. Go out and meet the customers – and anyone else who has an interest in your business.
A recent survey revealed that the average time between listing and sale was 9 months.
Why does it take so long to sell a business? Price and terms are the biggest reasons. Not over-pricing the business at the beginning of the sales process is a big plus, as well as structuring the transaction to include a reasonable down payment with the seller carrying the balance. Having all of the necessary information right from the beginning can also greatly reduce the time period from listing to closing.
Being prepared for the information a buyer may want to review or having the answers available for the questions a buyer may want answered is also key.
Here is the basic information that a prospective acquirer will want to review:
- Copies of the financials for the past three years.
- A copy of the lease and any assignments of the lease from previous sales.
- A list of the fixtures and equipment that will be included in the sale. Note: If something is not included, it is best to remove it prior to the sale or at least have a list of items not included.
- A copy of the franchise agreement if applicable or any agreements with suppliers or vendors.
- Copies of any other documentation pertaining to the business.
- Supporting documents for patents, copyrights, trademarks, etc.
- Sales brochures, press releases, advertisements, menus or other sales materials.
In addition, here are some of the questions that buyers may have. A prepared seller should have ready answers as well as the information to support them.
- Is the seller willing to train a new owner at no charge?
- Are there any zoning or local restrictions that would impact the business?
- Is there any pending litigation?
- Are any license issues involved?
- Are there any federal or state requirements, or environmental OSHA issues that could affect the business?
- What about the employee situation? Are there key employees?
- Are there any copyrights, secret recipes, mailing lists, etc?
- What about major suppliers or vendors?
A prepared seller is a willing seller, and having the answers to the above questions can significantly reduce the time it takes to sell a business. Using the services of a professional business broker can also greatly reduce the time period. They are knowledgeable about the current market, how to market a business and how to best advise a seller on price and terms. They can also recommend professional advisors, if a seller doesn’t have them already. Using advisors who are transaction-experienced can also shorten the time it takes to close the sale.Read More
Two businesses for sale could report the same numeric value for “earnings” and yet be far from equal. Three factors of earnings are listed below that tell more about the earnings than just the number.
1. Quality of earnings
Quality of earnings measures whether the earnings are padded with a lot of “add backs” or one-time events, such as a sale of real estate, resulting in an earnings figure which does not accurately reflect the true earning power of the company’s operations. It is not unusual for companies to have “some” non-recurring expenses every year, whether for a new roof on the plant, a hefty lawsuit, a write-down of inventory, etc. Beware of the business appraiser that restructures the earnings without “any” allowances for extraordinary items.
2. Sustainability of earnings after the acquisition
The key question a buyer often considers is whether he or she is acquiring a company at the apex of its business cycle or if the earnings will continue to grow at the previous rate.
3. Verification of information
The concern for the buyer is whether the information is accurate, timely, and relatively unbiased. Has the company allowed for possible product returns or allowed for uncollectable receivables? Is the seller above-board, or are there skeletons in the closet?