As we move into 2020, there are signs that the M&A market may be slowing down. Global trade issues, rising prices for target companies, and political uncertainty in the US all may contribute to reduced deal activity in the coming year. In this type of market, acquirers will take a harder look at potential acquisitions in order to minimize risk. Both strategic and financial buyers will be focused on buying “quality” companies, where potential risks are minimized through good practices of the sellers.
Well before actually putting a company on the market, business owners and entrepreneurs should engage in some “self-scouting” in order to identify potential issues that might arise during the transaction process that could cause a potential buyer to push back on price, or even walk away from a transaction. Transaction advisers often provide potential sellers with a sample due diligence request list, to show what a potential buyer might be looking for.
It is far better to identify (and fix) potential issues ahead of a transaction process, before a potential buyer comes in and points them out.
While not an exclusive list by any means, the items below are ones that often come up in due diligence review, and should be the among the things that a self-diligence exercise focuses on:
Business Records. Few things frustrate a potential buyer more than sloppy or incomplete business records. Potential sellers that have thorough, complete documentation of their business operations not only reduce the risk for potential buyers, but also give a buyer confidence that the business is generally well run. All material contracts with customers, suppliers, and service providers should be signed, dated, and include all pages and any riders, addendums and the like. Any contracts that have expired by their terms should be updated, either by a new agreement or an amendment extending the contract period. Any agreements that are not reduced to writing should be summarized and kept in a file, and to the extent possible confirmed via email or other correspondence with the counterparty. All employment records should comply with the applicable laws of the state that govern employee records (in MA, G.L. Ch. 149, Sec. 52C), and anything in the records that is extraneous or not consistent with the statutes should be removed.
Financial Records. There is no substitute for audited financial statements. Buyers will, in every circumstance, prefer audited financial to unaudited ones. Where audits are not practical, sellers should work with their advisers as to how to best respond to the likely requests from buyers. Sellers should almost always expect that buyers will engage an accounting firm to perform a quality of earnings report on a potential target, and should be proactive to address any questions that might come up, such as significant revenue/earning fluctuations or related party transactions. Many sellers engage accounting firms to perform a sell side quality of earnings report to flag these issues. At a bare minimum, financial statements should be rechecked for accuracy and completeness, and put into a standard format. Contingent liabilities should be quantified and identified. Discrepancies with GAAP practices should be identified and quantified, since many buyers will require a restatement of financial statements to comply with GAAP. Supporting information such as AP and AR aging reports should be reviewed and uncollectable or disputed AR should be removed or noted. Tax returns (including state returns) should be complete and consistent, with all supporting documents available for review.
Benefits Issues. Few problems can derail a transaction like an employee health or retirement plan that is not in compliance with applicable regulations. Buyers simply do not want the headache of having to deal with the IRS or DOL to resolve the seller’s problems. Uncollected 401k loans, improper matching contributions and health plans that don’t satisfy applicable COBRA or HIPPA requirements all give buyers serious pause, and at a minimum may result in a reduced purchase price to offset risk.
Business owners and entrepreneurs should expect that as we move into 2020, the “standards” for getting a transaction done will likely increase. Some pre-transaction review can make the diligence process go much smoother, and result in a higher price for sellers. It is a pretty rare transaction where time spent cleaning up potential issues doesn’t result in a better process/price.