Conduct Reverse Due-Diligence on Your Buyer
You and your partners spent years, decades, or perhaps generations, building your business. You decided it is time to sell your business, and you believe you identified the very best buyer candidate. Perhaps you’re right, but how do you know for sure? Answer all of these questions before executing a letter of intent with your buyer:
Why is your buyer candidate interested in buying your business?
This seems like a logical question to ask, but most sellers don’t take the time to find out why the company (or individual) sitting across the table from them is interested in making this purchase. Perhaps they already own a company in your industry and they are seeking to expand their client base and/or service offering. Maybe they manage an equity fund and they determined that businesses in your industry would generate the best returns for their fund. Ask, and find out why, they want to buy your particular business. Their answer will not only explain why they’re interested, but it may also give you ammunition to negotiate a better transaction for your shareholders.
Has your buyer ever purchased a business, or are they a first-time buyer?
Every buyer has to make their first purchase, so don’t rule out first-timers because of their inexperience. In fact, they may value your business more aggressively than repeat buyers because they view it as the right entry point into your industry. Experienced buyers may have developed a specific pricing methodology they won’t deviate from, capping the price they will pay for any acquisition. On the other hand, experienced buyers tend to know what they are looking for, and they will more likely align themselves with experienced transaction advisors, which enables them to accelerate the due-diligence process. There are tradeoffs when it comes to the experience level of the buyer, and you should know how many businesses they already purchased.
What type of business is your buyer looking for?
It is important to know if your buyer is industry agnostic, or if they are seeking a particular type of business. Many private equity firms are less concerned with the type of business, as long as the acquisition fits within their investment parameters. If they are looking at all types of businesses to buy, they may have a harder time securing the financing to complete your transaction. In the case of buying a service business, like a collection agency for example, the bank may not finance cash flow companies that have a limited hard asset base to leverage. Find this out up front to save yourself a lot of time and effort.
How long has the buyer been looking to buy a business?
Knowing how long your buyer has been in the market could help you negotiate a higher price or more favorable terms. If they’ve been on the hunt for the right deal for a while, they may be more desperate to buy your company. If they are just getting started, they may want to review multiple targets before settling down. However, knowing how long they’ve been on the market is not easy to find out. Your transaction advisor may have worked with them previously and may know the answer.
What size transaction is your buyer candidate seeking?
This seems like the type of question that can be answered early on in the acquisition process. The buyer may be looking for a company that is generating between $2-5 million in EBITDA (earnings before interest, taxes, depreciation, and amortization). You can easily determine if your company fits within their size range, right? Wrong. You may need to go through a process to “normalize” your EBITDA to reflect the true size of your company, and not what you’re showing on your income statement. Understanding what expenses can be adjusted is critical to a successful outcome. Far too many times, an owner will add back his/her salary fully because he/she is looking to leave the company post sale. They fail to adjust for a replacement salary to account for the person, or people, the company needs to hire, or promote, to fill the owner’s position.
What is your buyer’s timeframe to complete their due-diligence?
Experienced buyers tend to move more rapidly through their review process, whereas first time buyers may be slower to get to the closing. That said, negotiate the length of time allowed for due-diligence and keep your buyer’s foot to the fire by rapidly getting them the requested information. If they are acquiring a heavy asset business, their process will be considerably different than a service business, where there are no environmental issues, for example. Limiting the length of time that your buyer is reviewing your business will help you protect confidentiality.
What is your buyer’s approval process?
Find out as early as possible whether the buyer is board-driven, or who is responsible for making their buy decisions. You might do everything right during their due-diligence process, only to find out later on that their board had a different agenda and vetoed your particular transaction. If possible, meet with the decision makers to establish goodwill that can be used during negotiations, or post-closing, if you’re playing an ongoing role with the business.
If the process of reverse due-diligence sounds a lot like getting to know your partner before getting married, that’s because both processes are very similar. Like acquisition failures, many marriages end in divorce. Some digging on the front end may pave the way to greater success in either life-altering transaction.