Don’t dread the idea of submitting your business records to due diligence.
Embrace the process! It is a great opportunity to make money for comparatively little effort.
This potential for increasing your business valuation is often not well understood. It is all tied up in boosting the confidence of the purchaser or investor.
Too often due diligence is incorrectly seen as a bother or hindrance or something that must be endured. This misconception ignores the golden opportunity that a corporate due diligence process actually presents.
To explain that, let’s go back a step and consider what due diligence is and when it happens.
What is Due Diligence?
When negotiating a deal your aim is to convince someone that any money they put into your business will provide solid returns on their investment. They need to be sure of the facts and confident that they are making a wise decision. Due diligence is that assessment process.
Unless you are familiar with what is involved, it can sound a bit daunting to hear a due diligence team is going to show up and look into your business. Put in everyday language they are simply going to ‘check you out’.
Their aim is to:
- verify the information provided is correct; and
- discover any undisclosed problems.
The task is usually undertaken at the request of a purchaser or investor. Obviously, they want to make sure they are getting value for money and that they are not sinking their money into a venture that is plagued with financial, legal or operational problems.
Before they open their wallet, it is common to engage a lawyer or accountant or a team of such people to sift through the company’s records, to interview the directors and key officers and to delve into other critical areas of the business.
A due diligence audit will consider whether:
- intellectual property is securely held;
- key trading contracts are in place;
- key employee employment contracts exist;
- each business premises lease is locked in; and
- litigation exists or is threatened.
Your financial and corporate records will also receive detailed scrutiny. See our Due Diligence Checklist for deeper detail on what their review may examine.
How to Increase Valuation
So, how does any of this increase your valuation? The answer goes to the heart of the deal.
Any purchase or investment involves trust and a relationship. It is a fragile interaction. It usually starts with considerable caution and those relying on your word and representations are understandable wary. They have good reason to be that way. They are about to part with cash on the basis on the information provided to them. They want to verify those facts and confirm they will be getting what they are paying for.
Cost of Mistrust
Any sign of deception or even a simple lack of candour could soon erupt into open mistrust. Once that negative reaction occurs, the deal with likely sink or a substantial discount will be demanded in order to keep it afloat. This is where commercial due diligence outcomes turn into real dollars.
The process is all about maintaining trust and confidence. A purchaser or investor is usually easily scared off and at the end of the day you want that contract signed and that cheque handed over.
The best way to ensure a good due diligence outcome is to prepare for it from the beginning. Right from the start your business should build a system for maintaining good records. Some companies that have a lot of investment activity or purchase interest will even set up a special room which contains all these files in the one place. A ‘war room’ like this should be a secure area where the due diligence team can work their way through the files taking notes and confirming information.
Company Register
One of the first things they will ask for is the company register which is a file of the key business matters. It should include records of all shares issued or transferred, options granted, the appointment of directors and minutes of board meetings.
At the end of a review of those details and all of the other documentation included in the file, the due diligence team should be left with no concerns about the corporate governance of your business. They should see a clear paper trail of the company’s history and evidence that the business has been well run and administered with all regulatory and administrative procedures systematically and comprehensively followed.
The legal files should reflect a similarly thorough approach to business and a clear commitment to properly documenting deals and locking in contracts. They will want to know that key trading contracts are in place and the company’s right to payment is locked in. The reliability of cash flows and budget forecasts will depend on that contractual certainty.
Continuously Prepare
If you are going into your business with an eye on an eventual exit then preparing for due diligence should start on day one of your venture. Build a paper trail of your achievements and how you’ve grown the business. Make it as easy as possible for an outsider to understand what has been done and what the strengths of the business are.
Then when discussions with a purchaser or investor arise, you can go for the top dollar with the full confidence that your records will back your sales pitch. This is where due diligence preparation equates to income. Shoddy record keeping and business methods will either lose the deal or drive the price down.
Earn a Premium
There is a chance for easy money if you prepare properly. We all know that an enthusiastic buyer may be more willing to pay a slightly higher price or a larger premium. It is conceivable that you may be easier to push for a price that is 5 – 10% higher for a well organised business. Similarly, the price may be discounted for a comparable business if the buyer’s enthusiasm has dwindled through a lack of confidence in the product, the team or the records. Depending on the valuation, a change of confidence or enthusiasm could equate to a serious amount of lost cash.
In the thrill of the deal, you may find it far easier to push for a higher price than it is to work for that same amount of money selling widgets. Common sense says that should not be so but, then again, common sense is not that common.
There is always an emotional element to any purchase or investment. We are hard wired to enjoy the thrill of a deal or to gain satisfaction from an acquisition. Recognise that psychological reality and embrace its financial importance to you.
They are going into the deal in the belief that they can make a return on their investment – a belief that their money is safe or, at least, that the return justifies the risk. Their final decision to commit to the deal relies on that belief and confidence remaining intact. Do what you can to shore it up and allay any concerns and you should reap the financial benefits for your efforts.
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About Mark Toohey
