Due Diligence on the Flip Side: A Seller’s Tool Too

When thinking about due diligence in a merger or acquisition (M&A) context, we tend to think about it solely from the buyer’s perspective. Perhaps you have a picture in your head of a team of lawyers, CPAs, and other experts combing through financial records and legal documents, searching for potential liabilities or areas of risk that the buyer soon will be inheriting as their own. Depending on the size of the transaction, this process can take weeks, or even months. The seller often discovers the literal torment of “sleepless nights,” finding themselves in a period of limbo hoping that no major issues exist that could delay or terminate negotiations.

Imagine the following scenario: a husband and wife own a family business that they grew from the ground up. They want to sell because they are finally ready to retire. They already have a prospective buyer showing considerable interest in their company. The only remaining hurdle to get through is the buyer’s due diligence process. The finish line feels closer than ever. However, during the buyer’s due diligence review, the couple receives the crushing news that a significant exposure was discovered, completely unbeknownst to the sellers. This will either decimate the company’s selling value or cause the buyer to walk away altogether.

This is where sell-side due diligence – the process of proactively reviewing the company’s financial records and tax positions prior to entering into any negotiations – can really pay off. For the seller, the main objective is to not just successfully close the deal but to do so at the highest possible selling price in relation to the value of the company.
There are many advantages of conducting sell-side due diligence before negotiations get too far along. It is like getting your house inspected prior to putting it up for sale: it provides for a quicker and more efficient close as it provides the seller an opportunity to get their records and financial house in good order. In the M&A field, there is a well-known phrase: “time kills all deals.” Sellers often underestimate the volume of information that a prospective buyer will need to review and the seemingly endless number of questions that may follow throughout the negotiations. This can be incredibly nerve-racking as well as time-consuming for the seller, especially if simultaneously trying to manage a successful business and raise a family.

If the seller has an opportunity to compile this information in advance (and on their own schedule), items such as past financial statements, tax returns, legal documents, articles of incorporation, customer agreements, sales tax exemption certificates, and so on will already be collected and orderly. In addition, sell-side due diligence allows the sellers to get valuable insight into any hidden issues that may exist so they can ready themselves for the questions that undoubtedly will follow.

This gives the seller more control during the negotiation process: they can tell their story in their own words and highlight all of the positive things about their business. It also provides an opportunity to understand thorny issues and neutralize them in advance so prospective buyers are not armed with reasons to devalue the target. Issues often discovered include missed tax filings or inadequate policies and procedures around sensitive areas such as human resources, technology, and payroll, all of which can be easily rectified in a relatively short amount of time.

Taking such issues off the table upfront will pay off in the end for the sellers.

Sell-side due diligence is not just a defensive measure. Sellers can also gain valuable information they can use to go on the offensive. This can be in the form of simply presenting your business in the most positive light or maximizing the sale price. Most professionals who regularly conduct due diligence reviews probably have a majority of their experience working from the buyer’s side of the negotiation table. They know what drives (as well as what can significantly bring down) value in a prospective company. Being able to identify cost-saving opportunities can be just as important as being able to properly convey an overall positive financial health report and outlook for the company. In addition, the experts can provide critical insight into how to best structure the transaction to direct negotiations in a way that will benefit the seller economically and as tax-efficiently as possible. The end result of all of this typically leads to more cash in the hands of the seller at the end of the day. The cost incurred for sell-side due diligence can potentially pay for itself through increased sale price, let alone the nonfinancial benefits and avoided headaches discussed above.

In today’s M&A environment – one that is extremely fast-paced and riddled with incredibly complex legal and financial challenges – it is critical for sellers to put themselves in the best position to succeed. If nothing more, it will provide psychological benefits to the sellers by giving them peace of mind knowing that they will not get blindsided by unforeseen issues or questions.

James P. Swanick, CPA, is managing director in Global Tax Management Inc.’s Wayne office and a member of the Pennsylvania CPA Journal Editorial Board. He can be reached at jswanick@gtmtax.com.

Michael J. Tighe, CPA, is managing director with Global Tax Management Inc. and a member of the Pennsylvania CPA Journal Editorial Board. He can be reached at mtighe@gtmtax.com.