Pt 5: Selling a Business, Purchaser Due Diligence

In part 5 of our Selling a Business blog series, potential purchasers who submit the most attractive indicative offer letters are shortlisted to conduct due diligence in the next phase of the process. During this stage:

• A virtual data room is made available for the parties to review.

• They have an opportunity to ask questions and to attend site visits, which are undertaken outside of business hours, or discreetly during them to protect the confidentiality of the process.

• A draft sale agreement prepared by the vendors lawyer is usually loaded into the data room for the parties to review by the end of the second week of due diligence.

• The virtual data room is closed after around 4 weeks.

• A final offer letter, including a mark-up of the draft sale agreement is then submitted by each of the parties.

The Virtual Data Room

The virtual data room consists of folders containing the key documents of the business that are made available to shortlisted parties to review. It can either be created in:

• a free file storage service such as Google Drive and Dropbox; or

• a purpose- built m&a data room licensed by providers such as Ansarada and Intralinks.

As discussed in Pt 2: The Planning Stage, the data room should:

• include all the key legal, financial, operational and tax documents of the business;

• be reviewed by the vendor, their mergers and acquisitions advisor and potentially their lawyer and accountant for any issues that might concern a buyer; and

• all issues identified should be remediated before the start of the sales process

Examples of documents that parties shortlisted for due diligence will expect to review include:

Legal

• the company constitution

• key customer, supplier, employment and other contracts

• property leases

• title deeds

• licences

• insurance agreements

• certifications

• accreditations

• intellectual property registrations

Financial

• 3 years of historical financial statements

• a financial model supporting the normalised historic and forecast earnings included in the information memorandum

• the latest balance sheet

• reconciliations of stock, fixed assets, employee entitlements and other assets and liabilities on the latest balance sheet.

Operational

• Product lists and their pricing

• Schedules of revenue for the latest financial year broken down by product category and customer.

• Schedule of purchases for the latest financial year broken down by supplier

• Marketing material

• OH&S policies

• HR policies

• Internal audit policies

Anything considered commercially sensitive, like customer and supplier names should be de-identified in any schedules provided.

Tax

Tax documents are only applicable if the transaction is being structured as the sale of shares in a company. They aren't required for a business asset sale. If it is a share sale, then they would include:

• 5 years historic income tax returns

• Historic BAS statements reporting GST, PAYG and FBT obligations

• ATO statements that show the company is up to date with all its tax payments

• Statement from the Office of State Revenue that shows the company is up to date with its payroll tax payments

• Any correspondence with the ATO concerning the tax affairs of the company

It is important that all information provided to shortlisted parties through the course of their due diligence is provided through the data room, including all answers to their questions. This is because:

• the materials contained in the data room are disclosed against the vendor warranties provide in the sale agreement; and

• this limits the ultimate buyer of the business' ability to make a claim against the vendor for a breach of warranties post completion of the sale.

Significant Time Required by Vendor

Due diligence requires significant time from the vendor to answer all questions submitted by shortlisted parties, and to be available for site visits and potentially separate meetings. It is therefore advisable to:

• limit the number of parties shortlisted to no more than three to be manageable; and

• for the mergers and acquisitions advisor to leverage the competitive tension to negotiate improved offer letters from each of the parties who are hoping to be shortlisted.

An Ideal Time to Understand Buyer Motivations

When selling a business, the due diligence stage is an ideal opportunity for the mergers and acquisitions advisor to probe more fully into the motivations of each of the parties conducting due diligence; and to build trust between them and the vendor. This is critical to securing the highest price in the sale when final offers are submitted and negotiations to maximise them occur in the next phase of the process

Previous blogs in the Selling a Business series:

Pt 1: Process Overview

Pt 2: Planning Stage

Pt 3: Approaching Purchasers

Pt 4: Indicative Offers Submitted

Next blog in the Selling a Business series: