Every business owner who has ever contemplated selling will be aware of due diligence, that daunting process whereby a potential buyer commissions a third party to carry out an in-depth assessment of the business’ financial robustness and commercial potential in order to ensure that it is a good buy and to reassure the buyer that its initial price offered is fully justified.
Selling your company or part of your business can be a highly demanding and time-consuming process. It places significant strain on the company’s resources, particularly affecting key management and finance teams who must respond to the preferred bidder’s due diligence enquiries, involving comprehensive requests for financial, commercial, IT, legal, and HR information, while simultaneously managing day-to-day operations.
So, what can sellers do to prepare themselves?
One approach is to undertake sell-side due diligence, before initiating the sale process. Sell-side due diligence is typically divided into two types:
- Vendor Assistance, and
- Vendor Due Diligence.
Let’s explore the differences between these two concepts.
Vendor assistance is the process of working with a corporate finance advisor to assist in the preparation of key financial analyses, the early identification of risks and potential areas of focus to a buyer. The aim is to ensure that there are no surprises once the Information Memorandum (“IM”) has been issued to potential purchasers.
By conducting a thorough review and preparation of financial information, you can present accurate and credible data to third parties. This proactive approach allows you to address any issues and improve the price you can achieve. However, it’s important to note that while Vendor Assistance can support the IM as a key document in the sale process, buyers may perceive any outcomes from Vendor Assistance with a degree of scepticism as this is produced for the seller’s benefit as buyers will not be able to place any formal reliance on this. Consequently, buyers typically commission their own due diligence once they have preferred bidder status as they cannot formally rely upon the Vendor Assistance report provided.
At Price Bailey, we provide you with the benefit of our experience on buy-side transactions to identify potential areas of focus to a buyer, as well as providing insightful analysis and commentary of business performance.
Vendor Due Diligence:
Vendor Due Diligence (VDD) reports, on the other hand, are expected to be relied upon by the successful buyer and are typically prepared to support a controlled sales process where multiple potential purchasers have already been identified. A full-scope diligence is performed before any detailed information is provided to external parties, allowing you to identify and address potential risks before they become ‘deal breakers’.
The VDD report is shared with potential purchasers and the findings are discussed with them, giving the buyer the opportunity to ask any questions about the business. This process demonstrates the independence of the advisor’s work and the credibility of their findings. It’s important to note that the duty of care in a VDD report is owed to the purchaser, not the seller, and the successful purchaser will cover the costs of producing the VDD if it wishes to rely upon the contents.
What are the benefits of Vendor Due Diligence?
By applying detailed analysis to assets destined for sale from the perspective of the buyer, VDD helps vendors minimise risks, speed the sales process and maximise value creation. Increasingly, business owners are drawn to the idea of VDD. This practice has been growing in popularity in the UK and Europe over the last few years and involves the company that is looking to sell engaging with an independent advisor to perform due diligence on its behalf, but for the benefit of a buyer or investor.
Vendor Assistance and Vendor Due Diligence both offers several advantages, including:
- Identifying issues that could impact the potential sale price while there is still competing attention for the business allows you to resolve these issues proactively.
- A sales process that allows you to control the flow of information and the timing of the sale can be crucial in achieving the best price.
- It provides you, the seller, with greater control and transparency throughout the sale process.
In the current market, where competition for assets is high, sellers have an advantageous position. However, once you relinquish control over the due diligence process, the power dynamics can shift. You may start worrying about potential discoveries that could impact negotiations, and find yourself defending the price through to completion of the sale.
Identifying issues and allowing the seller greater control to mitigate them
By leading the dialogue through Vendor Assistance or VDD, you can address any issues before the reports are released or take steps to mitigate their impact. Even if an issue cannot be fully resolved, all bidders can evaluate it based on identical information during the competitive bidding stage. Without Vendor Assistance or VDD being undertaken and shared first, the first time a selected buyer learns of any concerns is when they receive their independent advisor’s DD report, by which time they are generally the only buyer left in the process, so it is much harder for the seller to negotiate from this position.
With sell-side DD in place, all parties receive the same information and interested parties do not have to individually bear the cost of undertaking their own due diligence at such an early stage. This keeps more potential buyers engaged in the sale process for a longer period, leading to increased competition and potentially higher bids. However, it is important to exercise caution when sharing commercially sensitive information with multiple interested parties during the bidding process. More sensitive details should be shared only with the selected preferred bidder.
To illustrate what we mean here, let’s compare it with the more common approach whereby a buyer (whether corporate or private equity) will make an offer for a business based on the information illustrated in the company’s IM. This tends to put the company in a good light for sale; highlighting USPs, historical and projected trading results, and providing an overview of the products/ services, workforce, management, customers and suppliers etc.
- The buyer will make an offer, subject to due diligence and contract, based on that IM and the ensuing due diligence is tasked to independently assess the target.
- Once an offer is accepted and the parties agree Heads of Terms, the successful bidder is afforded a limited period of exclusivity, the buyer appoints third-party advisors to analyse all the data and talk to the target management team to corroborate the detail that is set out in the IM.
This can be a worrying period for the selling business as external advisors undertake a detailed scope of review looking for irregularities and issues that might help drive down the valuation. You may be concerned that at some stage during that process, something might be found that means the deal won’t go ahead, or that the price or terms originally offered might be re-negotiated.
Instead, by leading the dialogue and undertaking sell-side DD, you can take comfort in knowing that any issues can be (or may already have been) resolved or mitigated.
Protecting deal value
One of the main aims of the diligence process is to establish the underlying financial performance of the target business by addressing the quality of those earnings in a number of ways. It also has regard to financial forecasts by looking at recent historical trends in the results to give you a guide as to whether the projected results appear realistic, being based on well-informed and sound underlying assumptions. Properly assessing future maintainable profitability has a significant impact on deal values as most buyers tend to bid on a multiple of earnings, in calculating their desired return on the investment.
Equity value v Enterprise value
Another important consideration is in calculating the target’s Equity Value against its underlying Enterprise Value, typically making adjustments for normalised working capital and any surplus cash (or debt) in the business, As we explore in our equity value vs. enterprise value article, there are no hard and fast rules for defining debt or working capital, but these factors can significantly impact the transaction valuation, so having an experienced advisor doing vendor due diligence helps to address these questions on your behalf early on in the process, which greatly reduces uncertainty when assessing competing bids for the company, where the alternative is for these matters only to be explored much later in the process typically.
The early bird catches the worm
If you choose to undertake sell-side DD, it is crucial to initiate the process as early as possible. Business owners should regularly consider their exit strategy, making it a recurring agenda item during board meetings. Starting DD well in advance will help the process go more smoothly. By planning early, you can mitigate and minimise risks, and find evidence of value.
In conclusion, whether you opt for Vendor Assistance or Vendor Due Diligence, starting the conversation early is key. Taking a proactive approach and investing in thorough preparation will benefit you as a seller. It allows you to anticipate and address potential issues, present accurate information, and ultimately improve the price you can achieve.
So, don’t wait until the last minute—start preparing for the sale process today.
We always recommend that you seek advice from a suitably qualified adviser before taking any action. The information in this article only serves as a guide and no responsibility for loss occasioned by any person acting or refraining from action as a result of this material can be accepted by the authors or the firm.