When a business owner decides to sell their business, the need to objectively assess the current condition of the company can often be overlooked. In failing to do this, the seller weakens their power of negotiation with potential acquirers. The best way to address this is through “reverse,” or “vendor,” due diligence.
Both processes involve having a third party assess the company in the same way that a buyer would, before taking the company to market.
With reverse due diligence, the results of this assessment are presented in a report to prospective buyers. This helps demonstrate that a third party has examined the company’s structure, and reassures buyers that any preliminary due diligence holes have been identified. With reverse due diligence the results are kept confidential by the seller.
Reverse due diligence allows the seller to prepare for issues that frequently arise in the sale process. According to M&A advisory firm Baker Tilly, both processes involve the following:
- An assessment of quality of earnings
- Quality of assets
- Tax due diligence
- Commercial due diligence (especially if the future revenue stream of the company is critical to the sale)
- Operational due diligence (if the operations are proprietary or otherwise critical to the value of the company)
Reverse due diligence provides the following advantages to sellers and their investment bankers:
- Provides the seller an opportunity to fully explain issues or circumstances that could be perceived as flaws by prospective buyers.
- Allows the seller to prepare for the questions and document requests that will invariably be part of the buyer’s research.
- Identifies potential deal issues for the investment banker, to develop appropriate negotiation strategies.
- Provides the investment banker with verified data to include in the Confidential Memorandum (and data room), which can assist in keeping any renegotiations to a minimum.
- Minimizes the potential for surprises from the buyer’s due diligence.
- Irons out potential kinks, thereby keeping a prospective purchaser in the process longer and extending the “competitive tension,” to maximize the price and structure for the seller.
- If reverse due diligence is thorough enough, it can help minimize the exclusivity period. The buyer need only roll forward the data required to validate their investment thesis.
Reverse due diligence is typically the last step performed before selling a business. However, it can also be conducted well in advance, to allow owners adequate time to correct or modify issues prior to exit. And if the end result is a higher business valuation or greater negotiating power, then it’s well worth the investment