Due diligence mistakes by sellers in mergers and acquisitions

What due diligence mistakes do entrepreneurs make in selling their company? With only 16% of all letters of intent eventually consummated in the sale of a company, the due diligence process is where many deals break down. Due diligence can involve a 25+ page list of requests for information. The buyer uses due diligence to manage risk, adjust its offering price, and decide whether to go through with the deal. Although buyers often fail to look at the right factors during due diligence, what mistakes during this critical phase of mergers and acquisitions can you as a seller avoid?

Here are four common mistakes sellers make.

1. Failing to do due diligence on the buyer.

This is the biggest mistake, and it happens all too often. Sellers often neglect to conduct due diligence because they are preoccupied with how to satisfy requests for information. However, sellers should investigate buyers in order to increase the chances that the merger or acquisition will achieve its desired goals. Although sell side due diligence is not a formal part of the process, there is nothing stopping you and your investment banker or lawyer from looking into the buyer.

For strategic buyers, you want to know about the acquirer’s corporate culture, its top management team, details about its plan to integrate your company, and its track record with acquisitions.

For financial buyers, you want to learn about the private equity firm’s operational style, its exit plan, and its track record with acquisitions.

2. Failing to prepare for due diligence.

A seller who is unprepared for due diligence can kill the chances of the deal being completed. At the very least, get ready by taking the following steps:

• Get your finances into order.

Have five years of cash flow statements, balance sheets, and income statements. Although you do not have to have audited financial statements, your books should be in auditable condition.

• Organize all contracts and legal documents.

This includes supplier and customer contracts; pending litigation and government investigations;intellectual property documents such as license agreements, patents, trademarks, and copyrights, and trade secrets. Prepare litigation documents, including complaints, answers, and arbitrations and mediations.

• Have operational data ready to present.

The buyer will want to see information on product quality, human resources, sales and marketing metrics, and customer satisfaction. Depending on the type and size of your business, the buyer will ask to visit your facilities. Expect the buyer to want to speak with the top management team.

3. Failing to cooperate with the buyer.

Sellers sometimes hesitate to provide a piece of information to the buyer. Worse yet, a target might outright refuse to provide information or access to management or production facilities. The desire to hide something is often based on the assumption that the issue, whether financial, legal, or operational, will kill the deal.

Yet, this lack of cooperation raises a red flag to buyers and can became a deal breaker. An acquirer expects a target to have issues. The issue that you are trying to hide might not be a deal breaker. But the fact that you are hemming and hawing might cause greater concern than what you are hesitating to reveal.

Trying to hide something from the buyer is a futile exercise. If the deal closes, the buyer will find out about any problems and you will take a hit through the escrow or the earnout.

So long as the request does not ask for a trade secret (think the formula for Coca-Cola), and is not unreasonably burdensome, you should comply with due diligence requests. There are other limited exceptions, but not very many. The tone of the buyer’s due diligence should not overly aggressive. If it is, that may portend your future relationship with the acquirer.

4. Failing to clear disclosures with your attorney.

Before you hand over sensitive information, make sure you consult your mergers and acquisitions attorney. Disclosures should comport with the terms of the Non-Disclosure Agreement between you and the buyer. You should expect to give out some sensitive information. There are limits though. For example, you don’t want or need to hand over your entire customer list. Telling the buyer that your top three customers account for 25% of your sales is sufficient. You can redact documents as appropriate, but first build that into the Non-Disclosure Agreement.

Don’t give away a trade secret. It is enough that the acquirer knows you have one. Telling the acquirer is not worth the risk that the deal will fall through and that the buyer will steal the trade secret. It is better to avoid litigation than to expose yourself unnecessarily.

When in doubt, ask your attorney.

Conclusion

Due diligence can be challenging for sellers because of the litany of requests received. By understanding the points of risk and what buyers will ask, sellers can avoid common due diligence mistakes during the sale of their company.

Douglas Y. Park

Twitter: @DougYPark