Surviving the challenges of due diligence is a critical step in the process of selling a company or raising capital. Unfortunately, many business owners do not make it through the process because they are not prepared or understand buyer/investor due diligence challenges.
Ten tips to surviving the Due Diligence process:
Be Transparent: No company is perfect! Business owners and their advisors must understand that experienced professionals conducting due diligence will find out every aspect of the business – good and bad! It is typically always best to be clear and transparent about the business and share both the good and bad aspects early in the process. This helps build trust, credibility and, most importantly, eliminates the frustration and embarrassment of having problems come out later in the process.
Have Clean Financial Records: Due Diligence typically starts with a review of the financial records. Starting the due diligence process off right is critical to setting the right tone and building credibility. There is perhaps nothing worse than financial records that are not accurate, well organized, or updated.
Prepare Financial Records to GAAP: Ideally, financial records will be audited, reviewed, or at the very least prepared according to GAAP (Generally Accepted Accounting Principles). Financial statements prepared according to GAAP provide clarity to the company's financial performance. Without this, there may be additional time and cost spent in getting financial records updated to these standards.
Appraise Physical Assets: All tangible assets of a business will be evaluated and appraised to the current market value in the due diligence process. It is critical to understand that capital expenses required to replace old or outdated tangible assets will be deducted from the cash flows of the business. This will impact the valuation. Review all tangible assets ahead of time and consider replacing or updating old, outdated assets.
Establish & Document Processes: The processes and controls of the business will be reviewed to see how well the business is managed and controlled. Solid business processes, systems, and controls reflect a business that is under control. Businesses with well-established processes and procedures that enable the company to run with little owner involvement receive higher value and fly thorough due diligence reviews.
Know Your Online Reputation: In today's world, online reputation is a critical part of the intangible value of the company. What customers say about the business in online reviews and social media will be one of the first things reviewed in the due diligence process. Understand that this will be thoroughly evaluated and improve if possible.
Minimize Customer Concentration/Maximize Retention: Businesses with a high Customer Concentration of 40 to 50% or more revenue tied up in one or a few customers will come under severe scrutiny. Companies with high customer concentration may not get through the due diligence process if there is a real risk that these customers could be lost. Customer Retention is another critical part of the due diligence process, as is Customer Churn (the number of customers that are lost and need to be replaced each year). The cost to replace customers is typically expensive, so high customer churn and low customer retention will result in decreased valuation.
Review Legal Documents and Exposure: Legal due diligence will include a thorough review of all contracts, corporate records, leases, financing, loan documents, supplier agreements, employee agreements, retirement plans, and all other documents. It will also determine if there are any past, present, or potential future legal issues or risks.
Human Resources: This is one of the most critical steps in the due diligence process. Buyers/investors will want to understand the organizational structure of the business and each employee's role. Adding competent employees through the acquisition is often a vital part of the acquisition strategy and value that is acquired. The organizational chart, employee reviews, and all employment records should be updated and well organized.
Protect Intellectual Property (IP): Trademarks, trade names, patents, proprietary technology, and trade secrets all increase the value of a company. All IPs should be registered with the appropriate regulatory agency, and all paperwork available for review.
These are some of the items to consider when going through the due diligence process. It is an intensive and exhausting process. Understanding and preparing for the process will not only ease the pain but can result in a higher valuation or sales price.
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