Avoid the Twilight Zone of Due Diligence
On October 2, 1959, the classic science fiction TV show ‘The Twilight Zone’ debuted. Rod Serling introduced 150 episodes and began the first with: “There is a fifth dimension beyond that which is known to man. It is a dimension as vast as space and as timeless as infinity. It is the middle ground between light and shadow, between science and superstition, and it lies between the pit of man's fears and the summit of his knowledge. This is the dimension of imagination. It is an area which we call the Twilight Zone.”
Unfortunately, it is a great description of the place that many business deals languish as they enter the due diligence phase – unless a seller is proactive enough to avoid it!
The due diligence phase of purchasing a business typically begins after an offer has been presented by a buyer and accepted by a seller. Up to this phase of a business transaction conversations can move rapidly with the seller and their broker fielding questions and having conversations with interested buyers. Energies and optimism can be high in this initial stage and once an offer has been accepted the business owner is looking forward to getting the deal done! Often however, this is the point in which a deal can slip into the Twilight Zone where things slow down and get a little weird!
The purpose of the due diligence process is for both parties to confirm the accuracy of information they have presented to each other and to ask for additional information. For the buyer it’s like hiring a professional home inspector when you buy a house – you want your deal team to poke around the business to make sure there are no hidden surprises. Buyers are likely to ask for additional business information for their deal team to examine and their lender may request additional information for the purpose of the loan qualification process. While they may have seen some of this information already, their deal team will want to verify its accuracy and assess the ability of the business to continue to produce profits into the future.
Moving through this stage of a business transaction involves a lot of people and a lot of factors, which is why it can quickly veer into the Twilight Zone, where it slows down.
- The seller and their deal team will want to verify the financial and professional qualification of the buyers.
- The buyers deal team members will ask for business information to examine on behalf of their clients and will be looking for any issues that may lead to problems after the sale. If they find issues they didn’t expect, they may seek to lower the price or adjust the terms of the initial offer.
- Attorneys on both sides will be passing the definitive agreement back and forth, negotiating the final terms of the deal and seeking tax advantages for their clients.
- Meanwhile the business owner/seller is working hard to keep the business running and maintain its value.
So, what can you do to avoid the Twilight Zone of Due Diligence?
1. Be prepared! Work with your deal team to identify the information buyers and their deal teams will want to examine. Have it ready and keep it current!
Information buyers are interested in verifying during the due diligence phase:
- Financial Statements
- Sales and Marketing Metrics
- Production and Operations Metrics
- Environmental or Legal Information
- Inventory Lists
- Equipment Lists
- Agreements with Landlords, Vendors, Customers, Employees
2. Be Flexible! The goal of due diligence is for both parties to verify information and strike the final terms of the deal. The result you want is to get the deal done, but keep in mind there are many roads which can be taken to arrive at a good deal. Rely on your deal team to suggest alternatives and avoid drawing hard lines on deal terms – instead, collaborate to see if there is another way to get to the result you want.
3. Be Quick! With so many people involved and a lot of moving pieces of information required during the due diligence process - time is not anyone’s friend. The quicker you can move through due diligence the more likely you are to successfully arrive at the closing table. The longer it takes the more fatigued the seller and buyer become, and the more emotions run hot. Sellers that drag their feet in providing information or can’t make decisions on how to respond to inquiries, may unwittingly be sending the message they aren’t serious about wanting to sell, or have something to hide. Keep your communication going with your deal team and rely on your broker to move the process along.
4. Be Patient! Expect that due diligence may take longer than you want, and you will be asked for a lot of information.
5. Remain Flexible! Don’t be surprised if a buyer asks to renegotiate some of the terms of the original offer based on something they discovered. Stay flexible and listen to their requests, then meet with your deal team to discuss what is reasonable. To avoid this situation, work hard to make sure your business doesn’t hold surprises for a buyer! Clean the skeletons out of your closet and make sure your inventory, asset lists and business reporting is accurate.
Due diligence doesn’t have to be an episode of The Twilight Zone if you proactively work with your deal team to explore buyer concerns and prepare your business to successfully navigate through the due diligence phase and arrive at the closing table.