Sell-Side Due Diligence
Sell-side due diligence during a company acquisition has become about more than just responding to a buyer’s due diligence checklist. Effective due diligence by the seller involves proactively seeking out and readying the most commonly requested types of information. It also requires that a seller be ready to answer a buyer’s most likely and common concerns and questions.
Read on below to find out what you’ll need to prepare in order to satisfy the average, diligent buyer.
What Tasks Does the Sell-Side Due Diligence Checklist Include?
The legal structure of a company is always of primary concern to a buyer. A seller should always know and be prepared to discuss the legal underpinnings of the company being sold.
- Collect all information about the company’s structure, including: an organizational chart, Governing and constitutional documents of the corporation, a list of jurisdictions in which the business is permitted to do business, minutes of any board, shareholder, and managerial meetings
- List all related party transactions
- Include the firm’s policies with respect to related party transactions
- Compile the CVs for all board members, managers, and vital employees
- Compile all information about the capital structure of the company that is not included on the Statement of Shareholder Equity
- Compile a list of all of the firm’s permits, licenses, and authorizations
- Describe the firm’s compliance policies and provide any related documentation
- Disclose if any officers or persons holding substantial numbers of shares qualify as Bad Actors
- Disclose if the firm is currently restricted from doing business under any regulatory or legal provision
- Collect any communications with a regulatory agency
- Include a list of all previous product recalls and significant warranty claims
More than anything else, a well-supported valuation by a reputable business valuation firm will provide a foundation for your asking price and negotiating position. Try to obtain this reasonably early and make sure that the valuation firm isn’t erring on the fanciful side when it comes to arriving at their final number.
- Obtain a current, “as-is” valuation of the firm
Taxation problems arise frequently after acquisitions when the due diligence process has been defective. Additionally, virtually any buyer of a business is going to want detailed information about any outstanding tax information. This includes information about tax policies within the company (with respect to employees and transfer pricing) and to pending tax liabilities owed to the state.
- Identify any deferred tax liabilities or assets and valuation allowances
- Outline all transfer pricing policies
- Outline all tax sharing or allocation agreements
- Justify and provide a written explanation of the classification of employees and contractors
- Include all tax audits conducted in recent history (up to five years prior)
- Include any loss surrenders made in exchange for research and development credits
- Describe property taxes paid by the firm in recent history (up to five years prior)
- Describe any overseas activity
- Describe any sale and leaseback transactions
- Disclose any matters related to the firm under investigation by any tax authority
- Disclose the tax base of any asset when it differs from its original cost
- Explain the firm’s current approach to tax planning and strategy
All current agreements need to be explained and described in full. This includes not just written agreements, but verbal and “handshake” agreements as well. The purpose of this exercise is to paint for the buyer a clear picture of the firm’s rights and obligations pursuant to all current agreements.
1. Identify all current contract obligations, including:
- Written contracts
- Verbal contracts
- “Handshake agreements”
- Joint venture or partnership agreements
- Any contracts terminable upon a change of control of the firm
- Indemnification agreements
- All real estate contracts and contracts involving real property or for the insurance thereof
- Employment, independent contractor, consulting, compensation, and severance agreements
2. Describe all current obligations, including:
- Financial terms
- Length of commitment
3. Identify any contracts to be entered into in the near future, including:
- Letters of intent
- Ongoing negotiations
4. Identify any crucial relationships with vendors, distributors, etc.
With respect to the firm’s accounting practices, in addition to identifying all of a firm’s procedures and practices with respect to accounting, the firm should describe any way in which their practices diverge from IFRS or GAAP. Importantly, the firm should also identify any accounting adjustments that can legitimately and realistically be used to adjust EBITDA upwards. Since the buyer will be looking for any reason to adjust EBITDA downwards, it makes sense to do the opposite in order to arrive at a fair number.
- Identify each way in which usual accounting practices differ from Generally Accepted Accounting Principles (GAAP) or International Financial Reporting Standards (IFRS)
- Identify all legitimate opportunities to adjust EBITDA (Earnings Before Interest, Taxes Depreciation, Amortization) upwards (as a purchaser will find any opportunity to adjust it downwards)
Identify accounting procedures used within the firm:
- Key personnel
- Software used
- Bookkeeping practices
The purpose of financial due diligence is to create a complete and compelling financial story for the buyer. They should be able to understand, based on your due diligence alone, what the past, current, and future financial state of the firm was, is, and is likely to be.
- Identify and highlight all recent capital expenditures and their likely impact on future cash flows
- Identify capital expenditures likely to be required in the near future and their likely impact on future cash flows
- Identify any seasonal or cyclical cash flow trends (in order to avoid under- or over-pricing the business, depending on the time of year)
Describe your sales patterns:
- Identify your largest and most important clients and products/services
- Identify any significant sales prospects
- Identify any significant new products
- Identify any significant discontinuances or potential losses of clients
- Collect all complete and current financial statements
- Specify and list any departures from GAAP and IFRS used during the preparation of the financial statements
- Collect all budgets and financial projections
- Include all Management Representation letters and any other communications regarding accounting controls
Buyers want to know that the firm will continue to operate without the current owner at the helm. A complete description of the leadership structure of the company will allow them to reach this conclusion.
- Describe your current leadership structure
- Explain how and why the current owner is dispensable
- Explain how and why all crucial employees will be retained
- Explain how and why all crucial contracts will be retained
Future, Unstated Liabilities
Buyers do not want to be confronted with surprise liabilities after the purchase of a firm. Full disclosure of all likely future liabilities is necessary in order to engender the confidence of the buyer.
- List any reasonably anticipated future liabilities not included in the financial statements:
- Environmental liabilities (clean-up costs, etc.)
- Legal liabilities (exposure to legal action or judgment)
- Include any actions or judgments related to employees or independent contractors hired by the firm
- Regulatory liabilities (exposure to fines, penalties, etc.)
- Include a list of any regulations that apply to the company on a regular basis
- Unperformed or overdue maintenance or upkeep on capital
Intellectual Property (IP)
In some industries, intellectual property is the biggest contributor to a firm’s final valuation. Extensive due diligence with respect to IP is essential to ensuring a firm legal and contractual basis for ownership of that resource.
- Compile a summary of all of the firm’s trademarks, patents, copyrights, and web domains and sites
- List all agreements and contracts under which the firm is granted the use of a third party’s intellectual property
- List all agreements and contracts under which a third party is granted the use of the firm’s intellectual property
- List all intellectual property used by the firm that is not solely owned by the firm
- Create a summary of all intellectual property litigation involving the firm that is either concluded, ongoing, or reasonably foreseeable
- List all instances in which a third party has infringed on the firm’s intellectual property (even if it did not result in litigation)
- Describe the company’s process for developing and protecting its intellectual property
Information Technology (IT)
Information technology acts as the backbone of many modern companies. A thorough understanding of a firm’s IT capabilities is necessary in order to properly value the company.
Provide details of:
- Any planned or current IT projects
- The firm’s practices regarding IT acquisition and deployment
- The firm’s practices with respect to customer IT support
- The firm’s practices with respect to web and internet automation
Compile a list of all significant software relied upon by the firm, including:
- The names of the programs
- Any vendor support contracts to which the firm is entitled
Compile a list of all essential IT personnel
Compile a list of all essential IT hardware, including:
- A diagram of all IT infrastructure
- The location of the hardware
- A description of the network architecture
- Detail the annual cost associated with all IT personnel, infrastructure, and software
- Describe all contracts relevant to the ownership and maintenance of IT
- List all IT consultants retained in the past, currently, and reasonably expected to be retained in the foreseeable future
List all of the firm’s practices with regard to IT security, including:
- A description of backups and recovery capability
- Data privacy policies and practices
- Data storage and encryption
- Antivirus and anti-malware capabilities
- Mobile device security
- Verification and monitoring of existing IT security
List all information held by the firm which is subject to privacy law and regulation
Describe any previous incidents regarding data intrusions, thefts, unauthorized access, and unauthorized alteration
Human resources can hide a multitude of complex issues and problems. Appropriate due diligence is necessary to reveal problematic relationships or employees that might jeopardize the health of the business. Because buyers will want to know about these issues, the seller should be prepared to disclose and discuss them.
- Include a summary of all employment benefits provided by the firm
- Detail the firm’s compensation policy, including bonuses, options and pensions
- List any disciplinary action taken against an employee or grievance filed by an employee
Compile a schedule of employees, including:
- Whether any are covered by disability legislation
- Whether any are currently on any form of leave or suspension
- Include the firm’s employee manuals and policies
- Explain the firm’s hiring policies and procedures
- Include a description of any loans made to employees by the firm and their current status
Reasons for Selling
An owner selling a business for “no reason” does not happen. There is always a motivating concern or purpose behind the sale. The buyer will want to know what that is and if there have been any previous attempts at selling the business.
- Describe and explain the current owner’s reasons for selling the firm
- Describe and explain any recent, unsuccessful attempts to sell the firm and the reasons they were unsuccessful