by Megan Romano
Due diligence is the term used to describe the process through which a potential acquirer evaluates a target company or its assets. Wikipedia defines due diligence as a term used for a number of concepts involving either an investigation of a business or person prior to signing a contract. Because it is often performed by the acquirer, due diligence is often overlooked by the seller prior to the time a purchaser comes forward to negotiate an acquisition. However, it is important for a seller to have prepared for the due diligence process in order to reach the most favorable terms of a deal. In addition, the seller will want to perform its own due diligence on the acquirer. This is particularly true if the acquisition involves a contingent payment, note or earn out that will be paid over time.
During the due diligence process, potential investors exercise care in examining aspects of the target’s past, present and potential future business in order to determine how much, if any, to invest. This process normally happens in two stages. The first is initiated when a potential investor shows interest in a target company. At this time, there usually is an initial exchange of information. The second, and more thorough, exchange of data occurs after the investor and the target company have determined that they would like to move forward with a potential deal.
Each transaction requires a different level of data gathering and presentation. The extent of data required is normally determined by the acquiring investor. Buyers and sellers normally want transactions to close rapidly. As a result, the time for data gathering can often be limited. For a seller, keeping certain commonly requested items organized and updated can alleviate some of the stress that goes along with the short time frame of the due diligence process.
Items Readily Available
Most financial data is fluid and ever-changing. However, there are several financial items that do not change often and having copies of those readily accessible items can speed up the data gathering process.
Some of the documents commonly requested in the due diligence process are annual financial statements, representation letters, accounting policies, year-end procedures, tax returns (including property, payroll and sales & use tax reports), employment contracts, leases, employee benefit plan documents and government prime contracts and subcontracts. Additionally, keeping accessible records of the articles of incorporation, operating agreements, S-corporation elections, shareholder agreements and any financing documentation is a good general policy to follow.
Keeping these key pieces of information readily available before transactions are considered allows companies to ease some of the data gathering burden during these time-sensitive stages of the transaction. This also gives the company time to review policies currently in place and allows the company to determine if any should be improved or changed.
Being Successful with Your Due Diligence
Not every initiated deal will be successful. However, for any company that is an acquisition target, either now or somewhere down the road, it is important to have a team in place that understands the goals of the company and shareholders for the transaction. This will help bring about the most favorable result for the parties involved. A key part to this is preparing for the due diligence process as early as possible. Equally important is understanding of the tax and business consequences of some of the basic forms an acquisition can take. For example, knowing the tax consequences of an asset as compared to a stock sale will help the selling company determine the acceptable sale price under different scenarios. This knowledge, along with the information gained from preparing for the due diligence process, is critical to the success of the acquisition transaction and helps to maximize value to the seller.
Relying on your efforts to perform all of the due diligence when a buyer suddenly appears will leave you in a time crunch and can ultimately result in a less favorable transaction. Instead, continually maintain, update and monitor the records, policies and procedures of your company so when that “once-in-a-lifetime” offer shows up at your door, it won’t pass you by.