By Brandon Fredericks, CPA | AGP Advisory, Leader
Our series has touched on many important topics through the financial due diligence process. As we think of the “typical” due diligence process, we sometimes get locked into this preconceived notion that due diligence only being after a qualified buyer is identified, after a letter of intent is signed, after the negotiations have started. But in this segment, I would like for us to change that mindset and start that process well before we “break bread” with a potential buyer. This segment is all about you—the business owner — looking to sell.
The first question we get when approaching the topic of sell-side due diligence is “Why would I want to invest money, time, and resources into this process when the potential buyers will be doing similar type of activities?” I find myself answering this question with my own question, “Would you sell your home without doing any pre-work to ready it for showings, open houses, and the eventual sale?” That question really gets our conversation going.
Think of a quality of earnings (QofE) report to a business sale as a home inspection is prior to a real estate sale. Homeowners wouldn’t purchase a new home without a thorough inspection, which benefits both the buyers and the sellers. The seller learns of any issues with the home, including any minor and easily resolved issues. Business owners should take the same precautions with a QofE report for their company. The QofE process will identify any issues to be addressed prior to the buyer’s due diligence, allowing the seller to present the financials to potential purchasers after adjustments and any easily resolved issues.
Providing buyers a QofE report will expedite the due diligence process. How great would it be to walk into an open house and be presented with a detailed inspection report from the home’s sellers? The same idea occurs with business owners that complete a QofE as they begin the retirement process. Critical details such as files, documents, and necessary financial items in the QofE report will be stored in one location when the buyer’s due diligence process begins. Having a thorough QofE report allows major items to be explained prior to the buyer digging in on their own – saving time for both the buyer and seller.
Business owners are often reflected in the phrase “too deep in the woods to see the trees.” Which makes perfect sense – proprietors are running the day-to-day management of their company, along with having a hand in every aspect of their business. Completing a QofE report benefits sellers to gain a full picture of their adjusted Earnings Before Interest, Tax, Depreciation, and Amortization, also known as EBITDA. Business owners should have a complete view of the true state of their company’s financials prior to finalizing a sale or retirement of the owner. As with a real estate purchase, buyers and sellers may often negotiate after receiving an inspection report. In a business transaction, negotiations can also occur as a result of a completed QofE. The report may identify potential seller benefits during arbitration that highlight the strengths of the business.
Hopefully this comparison between home ownership and sell-side QofE will now resonate in a different light for potential sellers. Before concluding this segment, let’s summarize in simple terms why sell-side due diligence is just as important:
- Shows the level of commitment and readiness to potential buyers of your willingness to sell your business.
- It shortens the time between the execution of letter of intent and date of sale signing/closing.
- Maximizing after-tax proceeds by addressing risks and optimizing the deal structure.
- Improving the accuracy of the historical and projected financial information of the business.
- Providing the buyer with a transparent, objective and credible view of the business.
- Minimizing surprises and maximizing transaction value by adding credibility and objectivity to the process. This especially rings true for those business that do not have a formal annual audit.
- Identifying adjustments that positively impact EBITDA (typically, potential acquirers only inform sellers about negative adjustments).
- Reduces time spent on satisfying information requests and questions raised by prospective purchasers, thus also reducing the distraction from managing the business during the sell-side diligence process.
- Provides the opportunity to provide more detailed information to prospective interested parties as well as improving their “confidence” in the quality of data supplied. This could potentially stimulate more parties to submit bids in an auction process as well as potentially raise the price.
The key to all this is providing yourself and your business enough time to put your potential sale in a position to succeed. The earlier you can start the due diligence process the more thorough and more benefits you stand to receive. If you have been contemplating selling your business, do yourself a favor and call your CPA to have that initial discussion.