Due Diligence – speed dating of the business world

​Due Diligence (DD) is a process whereby a potential acquirer evaluates a target company or its assets for an acquisition. Performing this type of investigation contributes significantly to informed decision making. It enhances the amount and quality of information available to decision makers and ensures that this information is systematically used to deliberate the decision and all its costs, benefits, and risks.

“DD is simply a process undertaken to verify and obtain further information that empowers the user to make an informed decision,” says Hetta du Preez, business broker for Aldes Business Brokers. Typically DD’s are performed by potential investors and also lenders or funders of a target company. The process will vary depending on the sophistication level of the person or company performing the DD, but in general it consists of gathering information over and above the high level information already provided by the broker or seller to:

• Verify the correctness of the information;
• Potentially reveal information that could have a significant bearing on the decision making process;
• Get a better understanding and feel of the day-to-day operation of the target.

“Think of the DD process as dating. During the first date you are interested to pursue your target further, but after subsequent investigation you find out that the target has an overbearing family or might not look so good in the sunlight. If you are unable to live with these issues, you make a call and find yourself back on the dating scene,” Du Preez explains. “During your DD process, you might find out that things don’t look as rosy as you thought initially and then you have to make the decision whether it is something you could live with or not.”

The outcome of a DD could be used to negotiate the price or payment terms after you have seen it “warts and all”. It also gives you the option to walk away from the transaction completely.

So why is it necessary to go through this process? Shouldn’t the correct information be disclosed upfront? One could argue this, but selling a business, like dating, is a process where you show the best the business can offer. The findings of a DD have a lot to do with personal preferences, interpretations and experiences. Some issues might be deal-breakers for some, but wouldn’t matter to others. “In business, ‘What’s good for the geese, might not be good for the gander’,” Du Preez explains.

The broker can’t do a due diligence on behalf of a buyer. Due to the fact that the broker will receive financial compensation when a sale is being made, buyers won’t accept the broker’s view as independent and correct. The broker’s function is only to introduce willing and ready buyers to a business on the information supplied to the broker by the seller.

The duty and responsibility to perform a DD lies with the purchaser. What should the purchaser look for? A typical red-light would be a sudden increase in closing stock in the financials, especially when the stock is hard to measure. This is done to manipulate the operating profit, hence affecting the valuation or asking price. Another red-light is a large increase in sales that is not consistent with prior years shortly prior to the sale and subsequent DD. The sales would then be debited afterwards to avoid VAT. That is why it is vital to compare the VAT returns to the posted sales. Business owners typically would try their best to pay as little as possible tax so VAT201’s are usually a good starting point to ensure sales are not overstated.

Prepare a list in advance of the information required and request that this be provided to you prior to an in store DD. This will give you some time to go through the information in your own time without the pressure of the seller hovering over you.

“I always say to my sellers that selling a business is hard work, but if the seller’s house is in order, providing the correct information should not really be hard work as it should all be at hand. The DD should also not be a scary event for the seller, as long as the information provided is accurate and disclose things that you might believe could be a concern prior to commencement of the DD,” Du Preez explains. Once something comes to the surface that has not been disclosed up front, and it is believed to be relevant, the trust will be broken. At best this might lead to renegotiation, and at worst a cancelled sale. Keep in mind that when a buyer requires finance, the bank would require a DD and they are trained to spot variances that might be risks.

For a seller it is important to not think of a DD as a witch hunt, but rather do your own DD prior to going to the market so that you are sure you can achieve the full value for your business and there is nothing that will come as a surprise. This will give you more confidence in negotiating the sale as well as speed up the process. The DD should also be a time for the seller to celebrate his achievements and emphasise the value that has been created.

“As a broker, I am proud to confirm that there are more successfully completed due diligences than not. As brokers, we use our extensive experience to advise and coach sellers and buyers, and we can spot a “foul smell” from a mile off. Therfore we choose to work with ethical business owners to ensure we can facilitate successful sales,” Du Preez concludes.