Sell-side Due Diligence Part One: Know Thyself – A Chat with Paris...

Sell-side Due Diligence Part One: Know Thyself – A Chat with Paris Aden, Valitas Capital

In M&A, due diligence isn’t just a tool for buyers; it can be a part of the seller’s strategy too. Paris Aden of Valitas Capital discusses why sell-side due diligence should start well before you bring your business to market.

Selling your company? What picture do you what to paint of your business before going to market?

No one brings their business to market without expecting some deep digging due diligence by potential bidders. It’s an essential part of the buying process. But sellers need to recognize due diligence isn’t only a tool for buyers, it can be a part of the seller’s strategy too.

In this article, the first in a two-part series, Paris Aden, partner and founder of Valitas Capital Partners, a boutique M&A advisory firm in Toronto, examines the benefits of hiring an advisory team to do sell-side due diligence before going to market. In the second part, we’ll look at the benefits of doing your due diligence on potential bidders once you’ve gone to market.

Paris Aden
Paris Aden, Partner, Valitas Capital

Part One – Know Thyself

Before you’ve even put your business up for sale, having a good handle on how you might look to outside bidders could put you at a strategic advantage when it comes to taking bids. Hiring a third-party advisory team to point the magnifying glass at your company will minimize surprises and maximize your business’ value further down the road.

“You get a chance to control the narrative by gathering supporting evidence for a positive story, and you pull together the tools to mitigate the weaknesses in your story,” says Aden. “You make sure, when you go to market, that you aren’t going to have a bunch of holes poked in your numbers… you’ll have the answers.”

The Valitas Capital Partners founder explains the benefits of hiring a third party to conduct due diligence on your business.

Show off the goods

Essentially, you’re developing a thesis for buyers, explains Aden. “You want to create these powerful hooks that make buyers want to engage in the process.”

Part of this is curating those highlights for the different types of bidders. “The financial advisor or M&A advisor’s role is to tailor the thesis to different audiences,” he says.

For instance, with financial buyers, the selling points (otherwise known as “acquisition highlights”) would focus on things like the returns they can expect to generate by investing in the company. Another set of acquisition highlights might be geared toward strategic bidders looking to add your company’s products to their offerings.

“In that case, you would focus very heavily on: ‘Here’s how this product is complementary to your current offering, here’s what your salesforce could do with this product,” says Aden. “Conversely, they might have a similar product, but the company you’re selling has highly complementary sales channels that the buyer doesn’t currently have.”

It’s about learning what your assets might be for particular types of buyers and developing a narrative around them ahead of time so it’s there when you start soliciting bids.

Learn your flaws… and how to defend them

All businesses have some element that could be perceived as a flaw by a potential bidder. Sell-side due diligence gives the company some time to analyze those flaws as viewed by an outside source and figure out how to respond to them. “You want to be able to discuss why these weaknesses aren’t very important,” says Aden.

Customer concentration is a common strategic weakness, particularly among small and medium-sized enterprises. “You might have one customer represent 30 percent of your revenue,” he says. “That’s a tough thing that can be very negative and detrimental to valuation and interest levels.”

But there are mitigation strategies to consider.

“You might say: ‘Well, yes, we have this one customer that’s 30 percent of our revenue but they’ve been a customer for 30 years and have never canceled an order,” he says. “You start to address all the reasons why that customer concentration isn’t a big deal.”

In other cases, Aden often encounters private companies where the owner’s compensation is far above a comparable role in the market.

“You might have an owner taking $3 million a year out of the business but market compensation for their role is $350,000 a year,” he says. To normalize, you add back $2.65 million dollars to the company’s historical profitability. “A lot of our diligence is around coming up with a defensible, normalized EBITDA number.”

Take a bite out of the bidder’s costs

In addition to building a narrative around your strengths and weaknesses, sell-side due diligence by an independent accounting firm can save bidders money, encouraging them to move forward in the transaction process. As an example, for larger transactions, Valitas brings the transaction due diligence group at Collins Barrow onto its deal team to provide third-party sell-side due diligence. Occasionally, buyers or lenders who require third-party financial due diligence from larger, established accounting firms may end up taking that third-party report at face value.

“It could save them anywhere from $60,000 and $100,000 in professional fees and makes it easier to step into the process,” he says. Private equity buyers often spend upwards of $250,000 in due diligence to get a deal closed.

“Imagine a huge chunk of that due diligence budget coming off their costs,” he says. While the best-case scenario of buyers taking that report at face value will not always materialize, Aden warns not to overlook the benefits to a buyer that opts to use their own firm. “That scope of work goes from a standing start to a review,” he says, adding that it could cut costs from $150,000 to closer to $30,000 – $50,000.

Time is your enemy in the deal process

And finally, there’s the time benefit.

“Because you’ve actually done the work up front and have the answers, you don’t have to waste two or three months gathering up the information in all the different formats people are looking for while you’re trying to run the business,” says Aden. “That review might take a couple weeks instead of a few months.”

Compressing the timeline is key. While specialized solutions like virtual data rooms can help protect sensitive stores of data being exchanged with third-party advisors or potential bidders, there’s always room for human error. A salesperson can make a comment at a conference or a customer could get wind that a competitor has been poking around your books. “From the time you initiate contact with the bidders to the time you close, you’re vulnerable to leaks,” adds Aden.

His advice: Control the process by engaging in strategic sell-side due diligence of your company.

“When you’re a step ahead, it inspires confidence in the management team, the buyer is more confident… they’re less inclined to dig deeper because they feel like management has a handle on it,” adds Aden. “That confidence and trust means they’re not looking under every stone because you’ve established some credibility – it sets the tone for a smooth due diligence.”

Stay tuned for part two

Next time, we’ll examine the benefits of doing your due diligence on potential bidders once you’ve gone to market.