insights
If you’ve thought of selling your business, or expanding through acquisition, then carrying out thorough diligence should be a top priority.
What does it mean when people talk about ‘diligence’? In the context of business sale or acquisition, ‘diligence’ refers to an independent financial review which seeks to benchmark the accuracy of a financial target against the terms of an offer, and to appraise its value. In short, it assesses how much a business is worth, and whether an offer reflects this.
There are many other areas (commercial, technological, management for example) that could be considered, should you or your buyer think it worth the time and money.
When it comes to financial diligence, if you are looking to sell in the next three to five years, we advise that you get your books in order now.
The quality and reliability of management information within SMEs can vary considerably. Financial diligence should cover at least the last three historical financial years plus ideally a couple of year’s forecasts. Management’s forecasting accuracy would be evaluated based on past budgeting capabilities (i.e. how close your budget was to actual performance).
You might have started to get an idea as to how much work might be involved now, but have you considered the following five tips?
Trite as the saying may be, it is important to prepare for diligence early on. A SME is typically run by an owner/manager who will be aware of what’s going on in their company without the need for masses of data. However, the new owner will need more than your word for how the company is performing. As they will be looking at three-plus years’ data, you need to start preparing these reports three-plus years in advance of sale.
A business will go through periods of profitability dips and peaks. It doesn’t have to be all rainbows and unicorns before your company can be sold. However, you should be able to justify the numbers you’re reporting. Any one-off expenses or income in a given period should be monitored so your profits can be adjusted to reflect the true earning potential of your company.
Embrace technology. There are a number of providers of data rooms., some better than others. Simple consumer file-sharing sites should be avoided for security and tracking reasons.
Within your own deal team, you should utilise rights management to monitor access to documents by individuals and advisers, and most importantly to segment information on a need-to-know basis. Rights management can help reduce exposure, especially around IP issues, should a deal fall through. A reputable provider is money well spent.
Even with articulated diligence goals and information requests, it is easy to become overwhelmed in a large data room with hundreds of contracts and spreadsheets. You should establish materiality thresholds for individual agreements and areas of exposure. You do not need to account for every penny. By establishing clear materiality thresholds, your team can focus their efforts where risk and opportunity are the largest.
Your corporate finance advisers will give you steer in terms of what you need to do to get your company ready for sale (and therefore for diligence). Tap into this resource – they will have dealt with enough transactions to know what you should be focusing on.
Even if your strategy were to change and a sale was no longer viable, preparing for diligence will have made your company stronger with a finance function that is reactive to market changes and able to provide management with the information they need to grow the company.
If you don’t have financial advisers to turn to, or you are looking for a second opinion, get in touch with PEMCF. We can help you to understand and comply with your due diligence requirements, whether you are buying or selling a business. It’s never too soon to start preparing: get in touch with PEMCF today.