Due diligence: Why every business owner should be familiar with that term
Are you ready for a due diligence?
Whilst due diligence is not a term of art, not a lot of business owners would be familiar with it given that they may not have gone through this process (as yet) or it is a perception that it is a black box best left to the advisor to deal with when the time comes.
Due diligence generally occurs when there is a sale of a business (including a merger/takeover) or capital raising (debt or equity). By now, some of you would be thinking that none of the above scenarios currently applies to you; therefore you are in the clear and can safely tune out. Think again!
To quote Dominic Carosa, serial technology entrepreneur, “due diligence starts from day one you are in business.” This is an approach that should be adopted by all business owners given the likelihood of a business looking for funding or the owner exiting the business at some future stage is more than (highly) probable. Now let put this into context:
You have agreed to dispose of your business for $12 million subject to the due diligence review, which has to be completed within 2 weeks. At this stage you are feeling fantastic, you have gone through the start-up phase, has grown the business and is about to exit (this is all in line with your business plan that you have revisited on an ongoing basis) i.e. you have ticked all the right boxes so far.
Next thing you know, you receive a lengthy information request from the vendor’s corporate advisor (which is the start of a domino effect). You cannot manage to locate half of the information requested and the other half of the information provided leads to additional queries. You turn to your advisor(s) to put together some last minute reasonably arguable position advice for the salient queries; this obviously adds to the transaction cost and extends the review time beyond the 2 weeks. During that time, the purchaser has taken you on a price negotiation tango and has managed to reduce the purchase price offer at least once. By the end of the process, you may find yourself with a much lower offer or the purchaser has been deterred by the commercial, legal and/or tax risks associated with the business (all unearthed during the due diligence review). The fantastic feeling that you had at the start is well and truly gone by now.
Whilst this is a hypothetical scenario, some business owners would have experienced the above to varying degrees. The take away message from the above is that you should always be ready for a due diligence review. This includes having all the necessary paper trail (for instance contracts, tax and legal advice and systems and processes documentations) and the appropriate risk management strategies in place that will help you identify any issue prior to having a due diligence performed on the business.
Some of the benefits that you will gain from being always prepared are as follows:
1. Be in a controlling negotiation position. Being due diligence ready will allow you to lead the price negotiation tango or at least prevent any further price renegotiation.
2. Maximisation of the value that you can extract. Remember risk and valuation is negatively related; having a less risky business means that you can extract a higher purchase price for your business.
3. Transaction cost savings. You will be less prone to rely on external advisors during this process given that there may be little or no additional work that will need to be done during the due diligence review to mitigate risks.
4. Time sensitive. A due diligence review is always a time sensitive exercise and being well prepared will ensure that the deadline will be met and it will be a smooth process.
And so the fantastic feeling continues….
Machel Advisory Services is a boutique business and tax advisory firm. Our focus is on providing strategic advice to businesses notwithstanding their business life cycle. Machel Advisory Services can assist in the structuring of a start-up, help with your business development while you are growing your business and assist you with your exit strategies. Seeking professional advice during the three phases (start-up, growth & consolidation and exit) is one of the many key ingredients for a successful venture