First the due-diligence test, then the purchase and sale agreement

The Denver Post


Gary Miller


By Gary Miller GEM Strategy Management

Posted:   04/19/2015 12:01:00 AM MDT

I received a call last month from Bob, a business owner who has his company up for sale. He recently received a letter of interest spelling out, among other things, the purchase price, terms and conditions and a due-diligence review process. The letter of intent was nonbinding but did commit to going to a purchase and sale contract — if the due-diligence analysis was satisfactory.

Bob was uncomfortable about the due-diligence process. He told me he was concerned about the continued requests for documents and explanation of specific accounting items and about the time it was taking to complete the process.

He worried the deal was going south. He wondered what he should do.

I told Bob to be patient. Due diligence is like getting a mechanic to look over a used car before buying it.

There are as many due-diligence processes as there are due-diligence lists, but most buyers focus on three broad areas: exposure to risk, sustainability of future growth and appropriate fit within the buyer’s organization.

Exposure to risk: Risk includes every threat the buyer can imagine. Beyond the normal review of financials, accounting, taxes, governance, legal and regulatory, the most obvious exposure is litigation, as plaintiff or defendant.

For example, assume a buyer is impressed with your intellectual property but wants to know if it is protected, if it is patented. Are those patents at risk of being challenged or due to expire? And have you taken pains to keep intellectual property in house, with technology measures and noncompete agreements?


Buyers may do an Internet search about the company for sale, looking for good and bad press. Reputation adds or detracts real dollar value.

Certain buyers factor in corporate social responsibility into buying decisions. Some firms incorporate “green diligence” and “corporate social responsibility” audits.

The buyer likely will ask about crisis preparedness: Do you have a plan to prevent data loss and security breaches and a plan to react if it happens? Are you insured against “Acts of God”? Do you have contingency plans to continue operations? Do you have a PR firm on retainer should you suffer some blow to reputation?

Sustainability: Sustainability due diligence focuses on the company’s ability to create enduring value for the buyer.

I told Bob to expect the buyers to evaluate his marketing plan, product development programs and the strength of his sales organization. Buyers may visit selected vendors, suppliers, and customers. They will measure customer retention, customer warranties, sales channels, purchase orders, reorder rates and his product portfolio.

In addition, expect buyers to review benefits and compensation, including insurance and retirement plans and other compensation, like company cars.

They’ll look deeply into financials, historic and projected. Have you met your financial goals historically? Are your forecasts in line with prior performance? Of hundreds of line items, this one gets the highest scrutiny, perhaps because buyers always pay a premium for a company that can generate predictable revenues and earnings.

Appropriate fit: In some cases, a buyer will acquire a company that fits so well with their existing organization that few changes will be required to integrate the two organizations.

Often, the value of the target acquisition is not the company itself but is related to how the target adds to the buyers’ existing portfolio.

I told Bob, in this scenario, the buyer may elect to sit on his board and leave management intact or make his company a wholly owned subsidiary with the only noticeable change being periodic strategic reviews.

More often, an acquired company will be integrated, and a buyer will be on the lookout for specific issues that may impede that process. This evaluation includes four factors:

  • Culture: The buyer looks for a corporate culture fit. This is a major consideration because many mergers or acquisitions fail miserably because they did not pay enough attention to the value structures, comparable business processes, management structures and differences.
  • Cooperation: The buyer will look for internal management cooperation. Staff defiance tells the buyer that the company will be difficult to integrate and may not fit within the evolved organization.
  • Management: The buyer will look for a mesh with management, asking who the top and bottom performers are. In a strategic acquisition, in particular, they will look for redundancy and synergies, identifying key areas where the buyer already has the organizational structure to execute similar operations, such as accounting and information technology.
  • Transparency: Unexpected news — a lawsuit, a major customer’s contract that won’t be renewed — may not be a deal breaker, but hiding it is.

I recommended to Bob three rules to follow: disclose, disclose, disclose.

If there are issues that might become a problem, tell the buyer all it needs to know sooner than later. If the buyer discovers hidden problems, those discoveries become reasons to abandon the deal. Inherent in the whole due-diligence process is trust.

Gary Miller is founder and CEO of GEM Strategy Management Inc., a national firm focusing on strategic planning, raising growth capital, M&A planning, exit strategies planning, preparing companies for sale and post-integration processes for middle-market companies. Gary is a key note speaker and syndicated columnist.  Reach Gary at 970.390.4441 or gmiller@


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