Seller's Due Diligence Checklist for Assessing Buyers
Effective due diligence on prospective buyers is a pivotal aspect of the sale of a privately held company, ensuring that the transition is smooth and aligns with your vision for the future.
When you've decided to sell your company, one of the most critical steps in the process is due diligence on you, the seller. The truth is, if there’s going to be mutual trust between both parties, the success of the transaction largely depends on selecting the right buyer who aligns with your vision and goals for the future of your business. In this article, we provide you, the seller, with a comprehensive checklist that we encourage you to follow in order to evaluate potential buyers effectively, especially when they show up with an unsolicited offer. We'll also delve into why it is critical to turn the due diligence table in order to understand a buyer's history, expectations, approach, organizational skills, roles, and likelihood of closing. Prior to signing a Letter of Interest (“LOI”) or a Purchase & Sale Agreement (“PS&A”) that is dependent on the buyer securing financing, this information gathering exercise is instrumental in shaping a holistic two-way due diligence process and ensuring a smooth transition.
Understanding the Buyer
Buyer's History: Uncover their track record and experience in acquiring and managing businesses. Ask about the types of companies they have previously acquired and their performance post-acquisition. A buyer with a successful history is more likely to handle your company effectively.
Expectations: Gain insights into the buyer's expectations regarding the transaction. Understand their long-term plans for your company, whether they intend to maintain its legacy or make significant changes. Aligning expectations is vital for a successful transition.
Approach: Ask about their approach to due diligence and the acquisition process. Are they meticulous and thorough, or do they prefer a more expedited approach? Understanding their approach can help you prepare accordingly.
Organizational Skills: Evaluate their organizational skills, as this can indicate how well they manage complex processes. A disorganized buyer will create unnecessary delays or complications during the transaction.
Roles: Determine the roles and responsibilities within the buyer's team. This includes who will be leading the acquisition, who will be responsible for integration, and any other key team members involved. Knowing their roles will help you coordinate with the right individuals on your team.
Likelihood of Close: Assess the buyer's commitment to the transaction. A buyer who is highly motivated and invested in closing the deal is more likely to be prepared, has the ability to overcome obstacles, and reach a successful close.
Create a Profile for Each Buyer
Once you have gathered information about the buyer's history, expectations, approach, organizational skills, roles, and likelihood of closing, you can craft detailed profiles for each prospective buyer. Similar to a customer avatar, these buyer profiles should include the following information:
Capital Sources: Prior to signing an LOI or PS&A, identify the sources from which the buyer intends to secure the necessary capital for the transaction. This information is crucial in determining the financial feasibility of the deal. If the buyer is not able to come to the table with this information via a commitment letter or a bank statement that shows source of funds, tread carefully. Much like buying a home, a smart seller appreciates a buyer who has received a conditional pre-approved commitment letter from the bank versus a pre-qualification.
Amount of Capital: Determine the amount of capital the buyer is comfortable injecting into the capital structure to complete the transaction. This will impact the overall bank financing, terms, and structure of the deal. If it’s a strategic acquirer, they should be able to provide their most recent financial statements that reflects a strong cash position and access to a suite of financing sources. If it’s a private equity sponsor, search funder, family office or other entity, they should be able to demonstrate their ability to inject 15%-50% of the transaction value in new cash monies.
Transaction Terms: Define the key terms of the transaction, such as the purchase price, payment schedule, and any earn-out arrangements. These terms should align with your financial goals without negatively impacting the ability of the company to continue operating and generating positive cash flows.
Team Size: Note the size of the buyer's acquisition team. A larger team may indicate a more substantial commitment to the deal and a higher level of expertise. However, level of expertise when it comes to due diligence and post-close integration trumps having a larger team, all else equal.
Team Members: List the names and roles of your key team members to be involved in the acquisition process. This helps establish clear lines of communication and accountability.
Expected Resources Post-Close: Understand the buyer's plans for the post-acquisition phase, including the resources they intend to allocate to ensure a smooth transition.
Ten Questions Sellers Should Ask Prospective Buyers
To gather the most critical information from prospective buyers, here are ten questions to ask:
How many acquisitions have you successfully completed in the past three years, and can you provide references from these transactions?
Of the last ten Letters of Intent (LOIs) you signed, how many resulted in a closed transaction, and what were the primary reasons for those that didn't close?
Can you provide a detailed timeline of the acquisition process, from LOI to closing, for similar transactions you've completed in the past?
What would be expected from my team during the due diligence process, and who specifically would you like to include in the due diligence team?
What is your strategy for the integration of my company post-closing, and how do you plan to retain key employees and maintain customer relationships?
Do you have a clear plan for financing the transaction, and can you provide information about the sources of capital you plan to utilize?
What is your long-term vision for my company, and how do you see it evolving in the next three to five years under your ownership?
Can you provide a breakdown of the types of businesses you typically acquire and your rationale for choosing them?
How do you handle potential deal breakers or obstacles that may arise during the due diligence process or negotiations?
What is your preferred communication and decision-making process throughout the acquisition, and how often can I expect updates on the status of the transaction?
FAQs
Q: Why is it essential to assess a buyer's history before engaging in due diligence?
A: Understanding a buyer's history provides insight into their competence and the likelihood of a successful transaction. It helps you gauge their ability to manage your company effectively, professionally, and in a timely manner.
Q: What role do buyer expectations play in the due diligence process?
A: Aligning expectations is crucial for a smooth transition. Different expectations regarding the future of the company can lead to conflicts and challenges down the road.
Q: How can knowledge of a buyer's organizational skills benefit the seller?
A: A buyer's organizational skills can impact the efficiency of the acquisition process. Sellers can better prepare and coordinate their efforts with a well-organized buyer. This same information also applies to sourcing the right lending partners. A lender who is inefficient and not able to communicate effectively can make the due diligence process fraught with challenges.
Q: What should sellers look for in a buyer's acquisition team?
A: The size and expertise of the acquisition team can indicate the buyer's commitment and ability to navigate the transaction successfully. However, the expertise speaks volumes more so than the size of the team. It’s all about balance and what makes sense for your company.
Q: Why is it important to understand the buyer's post-close resources?
A: Knowing the resources, the buyer plans to allocate post-closing helps sellers assess the level of support and investment in the company's future.
In your journey to sell your privately held company, due diligence on prospective buyers is a crucial step that should not be taken lightly. We come from the school of hard-knocks and oftentimes, as part of the seller’s due diligence/ transaction advisory team, we encourage our clients not to skip this critical pre-vetting step. By understanding a buyer's history, expectations, approach, organizational skills, roles, and likelihood of closing, you can make informed decisions that pave the way for a successful transaction and a seamless transition.
Disclaimer: The information, opinions and views presented in this writing are being provided for general informational and educational purposes only. They should not be considered as legal, tax, financial, or other professional of any kind. All such information, opinions and views are of a general nature and have not been tailored to and do not address the specific circumstances of any particular individual or entity, and do not constitute a comprehensive or complete statement of the matters discussed herein.
Readers should consult with their own legal, tax, financial, or other professional advisors regarding the applicability of this information to their own circumstances. It is important to remember that historical performance is no guarantee of future returns and that investing inherently carries risks. No representation is made that any specific investment or investment strategy directly or indirectly made reference to in this writing will be profitable or otherwise prove successful.
This writing is not and should not be construed as an offering of advisory services, or as a solicitation to buy, an offer to sell, or a recommendation of any securities or other financial instruments.