Entrepreneur: February 2014: Ask The Money Guy Q&A

Entrepreneur: February 2014: Ask The Money Guy Q&A


Question: What’s involved in due diligence when buying or selling a company? PUT SIMPLY, due diligence is where many deals go to die. It’s a term that strikes terror into the hearts of entrepreneurs who are selling, or wanting to sell, their businessesarid it should.

All sounds innocent enough: Due diligence is the extensive investigation a buyer performs to validate the information the seller provides and fully understand the risks involved in the purchase. Virtually all agreements to buy or sell a business are contingent on successful due diligence. And who determines that success? The buyer? and only the buyer. As a result, every little weakness uncovered in the process will end up as a demand for a lower price.

When I was CFO of a company that was buying a smaller business, we discovered that their top salesperson was paying cash kickbacks to the best customers. (The customers told us this when we asked if they were happy with the relationship.) After the salesperson was fired, we negotiated a $1 million reduction in the purchase price due to the increased uncertainty of future sales. The due diligence process starts as a relatively short list of questions and requests for information (see sidebar) but can extend and expand into a nightmare of time and energy that can distract sellers from running their business. Every aspect of the company and every decision ever made is being put through the ringer and second-guessed. And I mean everything: from the obvious, such as customer contracts and inventory, to the not-so-obvious, like HR policies and potential risks for lawsuits. It’s an ugly, painful process that, depending on how it goes, will determine not only the final price offered for the business, but whether it gets sold at all.

As a general rule, I grow concerned when I see due diligence taking longer than 60 days. It’s a red flag, usually indicating that something’s not right with the business or its management. It also means that the need for CPAs, lawyers and additional internal manpower is starting to eat into profits for the seller and creating costs for the buyer. For company owners who worked hard for years to build a company with the expectation that they’ll sell it for a tidy profit, due diligence can feel like a slap in the face, but only if they haven’t prepared for it. Don’t let that be you.