Strategic due diligence and buying a business
Due diligence occurs during the sale of the business when the price and basic terms of the deal have been agreed upon. Its specific purpose is to allow the buyer to verify the representations of the seller and continue with the purchase of the business or if they feel the details are not accurate, discontinue any further interest.
It’s also an opportunity for the seller to check the buyer will be able to complete the deal. For example, the buyer may need to obtain third-party financing. Due diligence allows the seller to see if that’s possible. Also, the buyer will bring a down payment to buy a business and the seller can ask to see a copy of a bank statement that shows the money is readily available. Perhaps the buyer is asking the seller to carry some finance in a sellers note. The seller would, therefore, like to see the buyer’s credit report and credit score to make sure they are a good credit risk.
During due diligence, sometimes buyers only focus on the historical performance of the business they want to buy and forget to consider how it’s likely to perform once the deal is complete. What has occurred previously is important; a buyer needs to know the historical financial statements of the business are accurate. However, for a thorough understanding of the business including its potential success or failure, buyers are encouraged to consider conducting strategic due diligence.
Strategic due diligence specifically addresses whether a deal is realistic and not simply overly optimistic on the buyer’s part. It should be considered in addition to the usual screening processes.
Strategic due diligence evaluates a deal and explores its performance from different angles. This includes looking closely at the health of a target acquisition from a legal, financial and operational perspective to help determine value, uncover risks and establish a fair purchase price including:
- Market. Is the market expected to continue growing at its current rate or is it maturing?
- Technology. Will technological advancements affect market activity and if so, how? Is the business using technology worse, the same or better than its competitors?
- Competition. How does the business compare with its main competitors be they local, regional, national or international? What is the competitive edge against new market entrants? Are there barriers to entry in this market that makes it hard for new competitors to enter? What type of consolidation or divesting activity has recently occurred in the industry?
- Customers. Not only identify major customers but also understand their buying decisions. Do they buy because they have a strong relationship with key personnel? Are there any negative indicators, like service or product complaints, low loyalty rates, or delinquent payments? Go online and research comments be they positive or negative to determine customer experiences and patterns.
- Pricing. Is it high volume low margin or vice-versa? Is the price used as a differentiator against competitors or new market entrants? Does their pricing policy fit with the future direction of the business and where the buyer wants to go? Is the industry changing and will, therefore, affect future pricing and is this positive, neutral or negative?
- Management. Will the existing management team be able to deliver on the deal’s anticipated value? Is the answer is yes, why? Do you think the management team can adapt to change? A new owner by default brings new ideas and new ways of things being done. Look for managers who can adapt to change and are capable of implementing decisions quickly. These characteristics will be crucial during the integration period.
Strategic due diligence is about research and good research equals more confidence in making the right acquisition decision and strategy. Strategic due diligence requires an investment of time and resources but you’ll also reap significant returns. In addition to contributing to an estimate of the company’s market value, the research results can help you communicate any strategic rationale to your investors, lenders, the board of directors, employees and other stakeholders.
Strategic due diligence also paves the way for a smoother, more successful integration.
For more immediate help with buying a business, you are welcome to send an email to Andrew Rogerson or give me a call on 916 570-2674.