This article deals with the final aspect of Step 3 of our firm’s six step planning process for helping business owners create an optimum succession plan for their business and exit plan which best meets their business and personal objectives. To recap:
Step 1: Help the business owner identify his/her life objectives including retirement income, manner of disposition of the business, and non-economic life objectives which add significance to the owner’s life;
Step 2: Determine where the owner (and business) is now and what the gap is in terms of meeting the owner’s economic retirement objectives; and
Step 3: Determine what steps the owner should consider to fill the gap by increasing the value (and selling price) of the business.
Last month we discussed key “value drivers” that qualified buyers look for in a business which increases the business’ value by increasing Return (profitability) or lowering Risk.
The value of your business to a potential buyer is directly related to the predictability that historical profitability will continue or increase in the future. Therefore, lowering the Risk that your cash flow will be interrupted (or decreased) in the future increases value.
This month’s article focuses on additional steps a business owner should take to reduce Risk as soon as he/she decides to sell his Company—conducting “due diligence” on his/her own business.
A qualified buyer will not normally buy a company without first learning everything there is to know about that company. That learning process is known as due diligence. During due diligence a buyer, his accountant, his lawyer and any other professional advisor he employs will examine every aspect of every contract, procedure, relationship, plan, legal structure, system, lease, employment policy and manual, tax returns, financial statements, etc.
This process requires an extraordinary amount of time and attention on both the buyer’s and the seller’s parts. That’s why we recommend that owners initiate the due diligence process as soon as they decide to sell their companies and have an indication from a transaction intermediary that the business is salable for sufficient money to meet their financial security wishes and needs.
Starting the due diligence process well before the buyer requests documents gives sellers the opportunity to remove any obstacle (i.e., clean up any messes) that might prevent a buyer from traveling a straight path to closing. Keeping the road to closing free from unnecessary impediments compresses the time between the buyer’s offer and the closing. In a sales transaction, time rarely favors the seller, so owners want to condense the process.
Buyers are looking for the skeletons in your closet and are very skilled at finding them. They are looking for malfeasance or undisclosed material risks. They will look for fraud (on the part of an owner or manager) or any misrepresentations you have made such as improperly recognized revenues or expenses, and any information you have omitted, such as: unpaid taxes, pending or threatened litigation or obsolescent business equipment, processes, products or services.
The buyer is also looking for information that would affect the value of the company and the advisability of purchasing it. Up to the moment due diligence begins, you have controlled the information flowing to the buyer. You give up much of that control during the buyer’s due diligence.
Finally, if the buyer’s search for malfeasance, misrepresentations or information that would affect the company’s value yields no results, the hunt is on for anything that the buyer could use to lower the price or improve its terms. And that ulterior motive—lowering price and improving the buyer’s terms—permeates the entire due diligence process. Is it any wonder that sellers hate (and that is not too strong a word) this process?
And, is it any wonder that we strongly suggest (as we do) that you and your advisors clean up every contract, agreement, stock book, record of corporate actions, manual, lease, or threatened law suit before you take your company to market?
If you have any questions about the extent or value of the due diligence process, please contact an experienced transaction attorney.
Next month we will discuss Step 4 of the six step planning process, who you want the business going to at retirement—a sale to an outside third party or a transfer to insiders?