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Preparing Your Company for the Deal of a Lifetime

Uncover Potential “Deal Killers” Before Your Buyers Do

By Mark Borda .

Selling your company, or a portion of the interests in your company, may be one of the most significant events during your life or career. A successful transaction will yield financial and operational benefits, while a bad transaction may have damaging and lasting consequences, so the stakes are high.

Sell-side due diligence can uncover potential “deal killers” before potential buyers do, giving you time to address issues before engaging in a sale. Here is why vendor due diligence is important, from a high-level perspective, and why your investment bankers or deal attorneys are likely to recommend conducting a vendor due diligence engagement in conjunction with preparing to market your company to potential acquirers.

To increase the likelihood of a successful transaction, it is important to assess the operational and financial circumstances of your company, prior to marketing it to prospective buyers. You can achieve this by working with an independent accounting firm to conduct a vendor due diligence engagement (i.e., sell-side quality of earnings report).

A vendor due diligence engagement is focused on providing potential acquirers with a deep understanding of a target business in advance of its own due diligence (i.e., buy-side due diligence). Key aspects of a vendor due diligence engagement include, but are not limited to, the following:

Quality of earnings report:
As businesses are often assessed and ultimately valued based on a multiple of EBITDA (earnings before interest, taxes, depreciation, and amortization), a sell-side quality of earnings report determines a company’s normalized, or sustainable, EBITDA during the prior several years. This is determined by adjusting a company’s EBITDA items, such as excess owner’s compensation; large, one-time expenses or expenses that are non-operational in nature; inconsistent application of accounting policies; or lost income from the impact of COVID-19.

Working capital analysis: 
Both sides of a potential transaction will negotiate a normalized, or target, amount of working capital to be delivered by the seller to the buyer on the closing date. A vendor due diligence engagement provides insight into certain aspects that are meaningful to understand when negotiating the normalized working capital, such as revenue trends, general industry conditions, and the identification of working capital accounts that are not considered “normal.”

Qualitative observations:
In conducting interviews with management, a vendor due diligence engagement also provides key findings that are of particular interest to a potential acquirer, such as the accounting policies and practices utilized by management, roles and responsibilities of key members of the accounting and finance department, and key accounting financial information systems and software, among others.

Ongoing advisory:
After the completion of the formal vendor due-diligence report and supporting information, a typical vendor due diligence engagement will include certain ongoing advisory services; including, periodically updating the report and key findings; coordinating due diligence requests from and interacting with a potential acquirer’s advisors; providing tax planning advisory services for a selling company’s owners; and, advice on various aspects of the purchase agreement, among others.

If you’re considering a potential transaction, it’s important to prepare your company and management team for a deep dive into your company’s current and historical financial and operational circumstances. Consider the following when evaluating the potential value a vendor due diligence engagement may offer. A vendor due diligence engagement can:

  • Provide further credibility to your financial statements and business operations (in the eyes of a prospective acquirer).
  • Increase the likelihood of successfully reaching a deal as the transaction timeline is shortened and potential “red flags” are identified prior to buyer due diligence (mitigating surprises).
  • Help you and your advisors maximize the potential value of your business by:
    • Establishing a strong business proposition with defensible EBITDA and support for key assumptions;
    • Avoiding “quality of information” issues; and
    • Allowing management to keep focus on the ongoing operations of the business throughout the transaction process.

Engaging a qualified advisor on the sell-side to conduct a thorough vendor due diligence engagement early in the process can reduce the likelihood of critical issues arising later on that could potentially kill the deal, and help maximize the value of your business, thus contributing to a successful transaction.  

Mark Borda, CPA, CFA

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