How to get through due diligence for a M&A transaction smooth and easy
November 5, 2021 •ROARK
Congratulations! You’ve successfully negotiated an LOI. You’re thrilled about your M&A transaction, exit, and a trip to Hawaii, but then the dreaded due diligence checklist appears. What are your options? Let’s talk about that. Today, we’re here to talk about how to get through due diligence smoothly and easily.
First and foremost, congratulations to you. Not everyone reaches this point in selling their firm. While there are many conflicting feelings, it’s still exciting. Typically, when you’re selling a company, you receive a lengthy list of due diligence requirements. This due diligence checklist maybe 13 pages long, small print, and have a million details.
Assign a project manager and smaller projects to complete your due diligence list.
So the first and most essential thing to do is ensure that you have assigned projects and need a project manager. Now, whether you’re the one doing it or someone on your team, either way, it’s a good idea. As a CFO, I frequently served as project manager for projects.
It’s critical to have a project quarterback since you’ll be interacting with a variety of individuals. There will be a lot of queries that arise from the information.
Pro Tip: Ensure the project manager has M&A experience with due diligence.
The worst thing you can do is hire someone who is a newbie. You’re looking for someone who has prior experience because there will be a lot of inquiries.
It does that by eliciting information from the prospect. It may raise concerns based on those answers. It might reduce the appraisal. The deal may be destroyed entirely as a result of it. Point number one, tip number one: ensure you have a competent quarterback for this list of due diligence.
Prioritize all due diligence items from highest ranking to lowest ranking.
It’s also essential to consider the list’s order of importance or priority.
So there are a few things that will be somewhat pacing. Some matters will be significant to consider when examining the agreement. Financial items are often essential, and simply set up the legal entity and ownership is critical to the transaction.
So you must first order the items in terms of priority. You’ll need to be able to complete tasks and prioritize the essential things first. That way, you can get the information to the team.
Evaluate team capacity and if experts are needed to complete due diligence.
So, look, there will be a million items on the list; your staff is already hectic as it is.
Very few companies run it 80% or 70% of capacity. The majority are around 90%-100%. So if you do your due diligence and look at the list, this is when you should evaluate things. Is it time to bring in new people to assist me? Do I need experts to help me?
Because, again, if you don’t have the appropriate individuals to guide you through this transaction, you may severely damage yourself or destroy it.
Understand how prepared you actually are. Is your house in order?
The next thing that you’ll look at is how prepared you are. Have you completed an audit of your financial statements? You’ll go over all of the earnings. You’ll go over legal issues. If your business information isn’t that clean or in very good order, you’ll want to consider hiring someone to assist with it.
Common Finance and accounting needs and mistakes to avoid in due diligence.
So let’s talk about from the financial side; since ROARK specializes in finance and accounting, what are some things you’re going to need to do?
And what are some of the common mistakes people make?
Accrual-based financial statements are analyzed and ready. (GAAP compliant)
First of all, just depending on, again, your relationship with your CPA, your requirements of your company. Some companies may have reviewed financials. Some may have no reviewed financials. Some may have audited financials. Your financials are essential because your firm will look and evaluate the company based on an accrual-based financial model in line with generally accepted accounting principles.
So while I’m an accountant, let me explain something. I’m the first to confess that everything they do following generally accepted accounting standards (GAAP Compliance) does not always make sense to business people. You don’t want any nasty surprises to rear their ugly heads when you’re selling that could cause a deal to fall through—surprises lower valuations. So, to ensure that your house is in good order, you must be confident. So please bring in the experts to be able to analyze it.
Review EBITDA and normalized EBITDA.
Furthermore, what you should look at, which is highly crucial in an M&A transaction, is EBITDA. So, as you can see, it all starts with your current financials. So what businesses aren’t going to always look at or tell you to look at are add-backs that may improve your EBITDA. It will be critical.
What you should be looking at is the present state of the company. What does it look like now, and what will it look like after? EBITDA has been normalized. So it’s not uncommon to see business owners put in cars and other expenses, or maybe not have expenses that they have forgone to cause their part of the ownership of the business, which you don’t want to do is take those, charges out, put them as non-recurring EBITDA items.
And look at other maybe non-recurring things that happen to be able to work through the EBITDA numbers. That’s going to be very important in looking at your valuation.
Have good projections ready.
Companies are going to ask and look for projections typically. That’s something that’ll be included in the total package and the due diligence process. It will depend on how well you do with your projections/forecasts, whether this is challenging or simple. You’re probably not as accurate if you’re a beginner at it. It’ll be much easier for you if you’re used to creating forecasts/projections and budgets and things like that. Not all projections are created equal. The adage “garbage in, garbage out” has never been more true. Let’s assume they want to make really great projections.
Then we’ll pump up the value further. People believe that we’re going to be great. Therefore it will be worth more. That may not necessarily be the solution. After that, other business owners come in and are very concerned about meeting their targets. So let’s make them conservative so they can sleep well at night, but they are way short. Now, this is turning into a story like Goldilocks and the three bears. This chair is too hard. This chair is far too soft. We need to find the right chair for this one. So it’s a two-way street. So if you overstate your projections and can’t deliver on them, the purchasing organization may ask whether they can have any faith in you. It causes hesitation. It creates anxiety. And they’re basing their evaluation off of this.
On the other hand, if your expectations are too low, you might be losing out on some opportunities. As a result, having an accurate financial expert on hand to assist you will be essential as part of the deal. That’s the same as what we discussed a little while ago regarding having excellent financial data.
Avoid surprises during due diligence.
The one thing that almost everyone dislikes is being caught off guard, and the more you surprise people, the less confident they are about the transaction and what might go wrong. So if you’re a buyer with little certainty, what can you do?
Nope, the answer isn’t that you pay a premium for it. That’s never the case. Sorry. I know that’s probably what you’re hoping for. No, what you do is lower the price. So that way, if there’s a difference or a gap, then you’re covering; you’re not overpaying. Look, you’re going to have reps and warranties.
That will be involved in this process, saying these are the best numbers, and I knew this stuff. And then sometimes they have earn-outs or buyouts depending on how the deal is negotiated. So it’s just the lower, the surprises. The better financial information that you can give folks is going to be very important for the deal.
Get information out to needed parties both timely and accurately.
The other thing, and I know you guys all know this from a sales perspective, T. K. D -what does that stand for? Time kills deals. So you’re going to want to make sure that you’re getting the financial information accurate, timely, and to the investors so that they can get through the due diligence process quickly and correctly.
Set up a due diligence room to make access to information easy.
You’re going to probably be going through what’s called quality of earnings QoE, which typically goes through an audit firm. The quicker you can move through this, the better the position you’re going to be in, and look setting up this due diligence room where you have this information so that all suitors can look at it is going to be critical and be able to move through quickly.
Pair your CFO with an M&A consultant if they don’t have M&A expertise.
And during due diligence, there’s going to be a lot of questions coming back to you and your team. This is where I highly recommend, especially for private companies, or sometimes you’ll have a CFO that is specialized in something else or controller, to call in a CFO with M&A expertise. This is where you need this specialist. You do. Some people specialize in M&A transactions, and this is the most significant transaction of your life. You want to make sure that you’re getting every, the best value out of it. And while some of the consultative fees may seem expensive. The question is, what do you get out of it? You could potentially get a higher value. You could get more credibility, and at the same time, you could keep from blowing up the deal. And these are where I start recommending- these are suitable investments to be able to make for our company.
So there are many things to consider in an M&A transaction, and getting through due diligence lists can be absolutely exhausting. My high recommendation is to look at what you have, look at where you need to be, and look at the timing of where you want to get there to be able to maximize your transaction and the success of your transaction.
We’re here to help, love, and serve. And this is the most significant transaction. Let’s make sure that we make it right. At ROARK, we’re here to help. Today, we talked about getting over, getting through due diligence smoothly and effectively.