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How Do Sellers Prepare for Due Diligence? The Importance of Starting the Process Early

 

As the owner or CEO of a medium sized company, you and the Board have just reached the difficult decision to sell the company. You have started interviewing brokers to assist you in the process, and your team has started preparing the book on the company.

It is now time to start thinking about the due diligence by the buyer, and start getting your information ready. Getting organized early will enable you to present your company in the most advantageous terms, helping maximize the price to the shareholders.

The first step is briefing the key people who are involved in the due diligence process for your company. Explain what the company doing with the potential sale, lay out the timetable, and what the process will be. While you may wish to keep the pending sale a secret from the rest of the company, it is my experience that once the due diligence process starts, the rumors start flying in the company. You need the weigh the pros and cons of making an announcement to the whole company vs. trying to keep it a secret to all but the critical team.

It is important to remember that selling the company may take six months to a year to complete, and you still need to focus on the overall performance and growth of the company. So while some of your key people are involved in gathering information, and dealing with representatives from the buyer during due diligence, you need to ensure that the company is staying on plan and meeting its targets. The current performance against the plan is an indication to the buyer of how much faith they can place in your long term forecast.

The next step is to select someone as the single point of contact for all data exchange from your company to the buyer. As the seller, it is critical for you to know what information was presented to the buyer’s team, and when. A central point of contact that is familiar with the company can review the information for accuracy, and help answer any questions.

 If you want the process to proceed smoothly, it is recommended that you set up a conference room (at your site or off-site) to collect all the information a potential buyer will need for the due diligence. Remember that you may go through this process with multiple potential buyers before the deal is closed, so once you have invested the time in gathering and organizing the information, set a process in place to keep the information up to date.

 

Listed below is some of the information to begin gathering in the information room. Each buyer will have their own due diligence checklist, but here is some of the core information that each will request:

 

  • All corporate documents including Articles of Incorporation, Bylaws, list of outstanding shareholders, minutes of Board of Directors meetings, and bios of directors and executive management
  • All financial documents for the preceding three years including audited financial statements, breakdown of revenue and profit by customer, and schedule of indirect expenses
  • All federal, state and local tax returns for the last five fiscal years and any correspondence with the IRS and state and local authorities regarding any tax issues
  • All contracts and material agreements with customers, including all correspondence between the company and the customers
  • All DCAA related correspondence included incurred cost submissions for the last three years, audit findings for the last three years, and current Forward Pricing Agreements
  • Detailed five year financial projections by customer, monthly for the first two years, and quarterly for the last three years
  • Detailed list of funded and unfunded backlog by contract
  • Employee related matters including schedule of employee information, employment agreements, incentive compensation agreements, stock option agreements, change of control agreements, loan agreements and collective bargaining agreements
  • All documents related to the company’s benefit plans including medical, life and disability insurance, incentive compensation plan, severance, earned time off, and other fringe benefits
  • All company property and equipment and the current depreciation schedule
  • All company leases  
  • All business insurance policies including casualty, general liability , workers’ compensation, business interruption, key person, director’ and officers’, and errors and omissions; a list of all claims for the past five years
  • All outstanding and pending litigation
  • All intellectual property of the company including inventions, patents and trademarks

While this list only provides a high level summary of the information you will need to provide to a potential buyer, it will help you get organized and enable the buyer to begin the due diligence as soon as the Letter of Intent is signed. It will also assist in a smoother, faster and more efficient due diligence.

Peter Dwyer is Co-founder and Managing Director of EdgeStone Consulting, specializing in acquisition consulting and due diligence support to firms in the federal marketplace. For additional information, contact Peter Dwyer at pdwyer@edgestone.net, or review more detailed information at www.edgestone.net.