Managing Due Diligence: A Key to Closing More Deals

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We all know that business brokerage is a "numbers game." That is, we start with mass marketing, convert leads into a listing meeting, a listing, an offer, and if we are lucky, a closing. Each step along the way, some of our efforts bear no fruit, wasting the Business Broker's precious time. Therefore, it is in the Client's and our best interest to find ways to increase the chances of a business closing.

Importance of Due Diligence

Although there are no reliable statistics, it is estimated that as many as fifty percent of all business transactions which make it to the LOI/accepted offer stage, fail during the Buyer's due diligence (DD). DD is a crucial element that occurs, to varying degrees, in every business transaction. This article outlines some basic guidelines on managing DD.

Business Broker's Role

You (the Business Broker) do not conduct the DD for the Buyer. As the team drives towards the end zone (i.e. a closing), you act as quarterback, directing it and making sure that the DD process stays on course. You must anticipate any impediments to closing as early in the process as possible, and begin to plan how to overcome those DD obstacles. Your job is to control the DD process, and manage those tasks that are the responsibility of others in the process. These are the two keys to closing more deals.

Educate the Seller

At the initial listing meeting, it is essential to begin educating the Seller, and managing his/her expectations. At that initial meeting, you should:

• Describe the selling process, when DD occurs, and its purpose.
• Discuss what Buyers will want to see, and the downside when a Buyer discovers that things disclosed about the business were enhanced/puffed, or that there are missing documents.
• Give the Seller an idea of what will be required; show them a typical list of DD items the Buyer will be requesting, and get a sense of whether the requisite documents are available for the business.
• Do all of this before you take the listing.

After listing the business, collect as many of the documents that will be required during DD as possible; why wait? These documents are typically the same things you should have in your file anyway. They are required to write the Business Summary, Confidential Memorandum, or Teaser.

Educate the First-Time Buyer

It is just as essential to educate First-Time Buyers about DD:

• Inform the Buyer about the process, and that DD is for their benefit.
• Give them a typical DD checklist, but make certain to disclaim it as an "example" and "not meant to be complete or appropriate for any specific business."
• Discuss the time required for DD.
• Give them that "warm" feeling that they will be able to review everything to their complete satisfaction, before they commit to the purchase.
• Talk about obtaining professional assistance; the Seller and the Broker are not the Buyer's advisors.

Include a Due Diligence Checklist in the Asset Purchase Agreement

Have the Buyer include the items on their DD checklist, which they plan to use in the Asset Purchase Agreement (APA). Although the APA often includes a blanket statement that the purchase is "subject to the Buyer's inspection of, and complete satisfaction with, the business records," it is a good practice to include the major items the Buyer expects to review in the APA. The objective here is to avoid surprises; neither side should claim that they "didn't know" that something was asked for or should be done during DD.

Include a Due Diligence Timeline in the Asset Purchase Agreement

It is recommended that you also include a timeline for DD. Describe the specific time period (number of days) and the date certain by which DD must be concluded. When the Seller executes the APA, the Seller is agreeing to provide the information, assist the Buyer, and adhere to the timeline. The Buyer usually has the right to ask for additional material and be satisfied with all aspects of the business. The objective is to avoid timing surprises and allow the Seller's team to plan ahead.

The length of time required for DD is driven by the complexity of the business transaction, the information required, and the availability of the Buyer, the Seller, and their respective Advisory teams. You should educate the parties that one of three things will happen at the end of the DD period. Either escrow opens, the DD period is extended by mutual consent, or the Buyer's offer terminates. DD is not a "nebulous term;" it is a structured process, with objectives and timelines.

Create a Due Diligence Checklist and Status Report

After both parties execute the APA, turn the DD checklist into a "Contingency Sign-Off List". It becomes a tracking device for the following:

• Who is responsible for providing the information or assisting the Buyer.
• The date that the information or assistance was provided.
• The date that the Buyer completed DD on that item, thus removing that "contingency" from the list.

In Main Street transactions, usually the Broker handling the Buyer's side maintains the list. That Broker should keep all parties involved in the process (Buyer, Other Buyer Advisors, Seller and Seller's Broker and Advisors) informed as the tasks are completed throughout the DD process. Many times, in M&A transactions, the list is maintained by the attorney representing the Buyer.

Create a Document Repository

You should create a central repository for the data the Buyer will need for DD. Depending upon the particular circumstances surrounding the transaction, the following three DD document levels can be set up:

• Basic DD: Set up a 3-ring binder with a tab for the DD checklist and each group of relevant documents.
• Complex DD: Set up a physical "data room," where the Buyer and Buyer's advisors can conduct an inspection of the documents, and request copies of whatever they need. Do not allow the Buyer to remove the originals from the room. This controlled environment can be set up at someone's office; i.e. the Seller's, the Broker's, the Seller's Other Advisors, or a neutral office.

• Advanced DD: Scan certain DD documents and create PDF files for each one. Create a special, password-protected web page on the back end of your website. Post all the documents on the virtual data room. Give a password to those authorized to access the data (Buyer, Buyer's Advisors, Lenders, etc.). Track when, what, and by whom specific DD documents were viewed and downloaded. This saves a lot of paper, time, and travel. It also allows multiple parties to conduct DD simultaneously. PEGs and Lenders love this!

When is Due Diligence Complete?

Completing DD is influenced by two factors, tasks and time. When the Buyer has signed off on all tasks, regardless of whether the allotted time has expired, you must ask if the Buyer is ready to open escrow. If the Buyer agrees, convert the DD Checklist into an "Acknowledgement of Due Diligence Completion" document, have the Buyer sign off that DD has been concluded and they have reviewed and accepted everything. Keep that document in the file, in case you need it.

In summary, your chances of closing more deals are directly affected by how well you manage the DD process.

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