We’ve all had our personal moments of buyer’s remorse; a regret from having made a purchase.  According to AMFAM, American Family Insurance, buyer’s remorse occurs 52% of the time with home buyers.  When you are about the shell out 44 billion dollars, you want to make sure you’re about to get what you imagined.  For the great Elon Musk, Due Diligence is very important.

 

 What is Due Diligence

We are not lawyers; respectfully we cannot speak to the merits of Twitter’s legal case brought against Mr. Musk.  But we do know something about due diligence when assessing a business’ worth. What is due diligence?  Due diligence is simply a short investigation of a potential investment. The purpose of due diligence is to confirm the accuracy of the information being presented by the seller of the business.

 It is imperative that a buyer confirms cash flow and the respective other revenue supporting activities that contribute to revenue. (In Twitter’s case, it would be members and bots).  Also, due diligence should be performed by the seller.  You’ll want to make sure the buyer has good credit (if financing is required), background in the industry and sufficient assets to finalize the transactions.

 

How long should a Due Diligence review take?

 It truly all depends on how complex the business transaction is.  Purchasing a local deli, burger franchise, or car dealership is not as complicated as purchasing a company that streams augmented reality entertainment with a real time social media interface.

 To purchase a mid-size company with revenues between $1M to $40M, the due diligence process can last up to 90 days. Companies with revenues exceeding $40M and as high as $100M, due diligence can take up to six months.  It truly depends on the complexity of the business.

How do you perform Due Diligence

Note how many participants in a Due Diligence review depends on the complexity of the transaction. When considering which areas of the business you would like to scrutinize more, ask yourself this question: what is important to me finalizing this deal. Keeping in mind how this acquisition lends to your competitive advantage.

Be conservative in your request to seller but committed to the key questions you need answered and verified in the deal.  Core documents to ask for are:

  • Financial statements (4 – years if applicable)
  • Tax statements (4 – years if applicable
  • Assets list with respective schedules
  • Membership information
  • Accounts payable and accounts receivable summaries
  • Patents, copyrights, and trademark filings

Once the Due Diligence review is complete, it’s best practice to contract with the seller to participate in a consulting role during the “turning-over” process.

 

What happens when the Due Diligence Expires?

Another best practice when considering a merger or acquisition, is for the buyer to issue a Letter of Intent or (LOI).  Some of the aims of the LOI are:

  • Set forth the terms of the parties involved,
  • How long the due diligence review will last,
  • What happens after it ends,
  • Clear up the key points of that need to be renegotiated,
  • Protect all parties involved in the deal, and
  • Announce the nature of the deal, such as a joint venture or merger between two companies.

Once due diligence is over, there are three options:

  • Continue forward and close the deal
  • Back out of the transaction or
  • “Re-Trade”, or renegotiate the purchase price

Re-Trading is renegotiating the price of the valuation of the business after it had an agreed upon purchase price, which was higher.   Re – Trading is a viable move only when you discover something where materiality effects the initial purchase price valuation.  Materiality events or information are any events or facts that would affect the judgement of an informed investor.

March 2018, Harvard a professors stated “95% of purchasing decision are subconscious” or emotional.  Having an emotional connection with a purchase is not bad.  This fervor will buttress the business into great growth.  But, during the courtship of negotiations, trust the seller and verify what they say.

Before your next acquisition perform your business due diligence.  To learn more about our Financial Advisory services get in touch.