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Sell-Side Due Diligence: A Smart Deal Strategy for Minimizing Surprises and Maximizing Value


1/27/15

With an increased level of capital chasing a limited number of quality deals, sell-side due diligence is gaining momentum with companies contemplating a transaction. Why?  By thinking like a buyer in advance of a sale and focusing on areas of concern to an acquirer, a seller can boost its credibility with buyers, reduce the possibility of unwelcome surprises during the sales process, shorten the buyer’s due diligence process, and increase the likelihood of a successful transaction.

To help companies considering a transaction determine whether sell-side diligence is right for them, the following addresses some of the most common questions about the process.

What is sell-side diligence?

Paid for by the seller, the product of sell-side diligence is a report that showcases the company and provides buyers with financial and operational information from which to evaluate the business and potentially make an informed offer. The seller has the opportunity to vet the report for factual accuracy and content, and can address issues proactively, which is not possible when buyers perform their own diligence. The intent of sell-side diligence is to reduce the overall diligence costs by getting ahead of the issues to decrease the chance of unnecessary delays in the sales process. It is conducted from a buyer’s perspective with the goal of increasing buyer confidence; however, seller management retains control of the scope. For those concerned that sell-side diligence will disclose too much information, keep in mind that it allows the seller to have greater knowledge and control over the information presented, and potential buyers are likely to identify the same or similar issues anyway.

What does sell-side diligence entail?

Sell-side due diligence focuses on the issues relevant to potential buyers, including an in-depth analysis of the financial condition of the company being sold.  Since one of the major concerns of buyers is the reliability of financial data offered by the seller, demonstrating the accuracy and credibility of financial data is a key goal of sell-side due diligence. In addition, sell-side due diligence helps the seller prepare for negotiating the sale of the business by identifying issues that may become topics of conversation during the sales process.

Typically, sell-side diligence focuses on the areas of most concern to buyers, including:

  • Business environment

‒ What is being sold (e.g., assets, stock)
‒ History, timeline, and structure of the business
‒ Company’s competitive and regulatory environment
‒ Primary business resources
‒ Issues and/or opportunities inherent in the seller’s business
‒ Opportunities for the buyer to create and maximize value

  • Operations

‒ Products and services
‒ Strategy for procuring, producing, distributing, marketing, and selling
‒ Governance policies and procedures
‒ Quality of management and other personnel
‒ Information technology
‒ Cash generation of the business
‒ Historical and future capital expenditures
‒ Cash taxes, including any costs to repatriate cash

  • Historical results

‒ Quality of earnings, quality of working capital, net debt, commitments and contingencies, cash flow, seasonality, potential exposures (e.g., off balance sheet liabilities, etc.)
‒ Tax footprint – current structure and whether there are potential liabilities or opportunities to capture value
‒ Employee benefits (retirement plans, funding obligations, etc.)

Sell-side diligence may also include an analysis of whether the growth projected by company management appears reasonable based on historical performance.

The objective of sell-side due diligence is to identify issues that would be uncovered during buyer due diligence and either address them ahead of time or prepare responses to challenging questions. For example, it is not uncommon to identify issues ranging from state and local tax compliance to off balance sheet liabilities. Company management is given the opportunity to address such issues. In addition to uncovering issues, sell-side due diligence may sometimes identify positive findings such as add-backs that will improve the seller’s numbers.

The sales process is complex and can easily monopolize management’s time, distracting them from the day-to-day demands of the business. A sell-side advisor can aid management by assuming responsibility for many of the tasks associated with the sales process, leaving the management team to focus on day-to-day operations. Since each deal is different, an advisor’s involvement in the sales process can range from providing limited work on the front end, to the preparation of a comprehensive report that can be provided to prospective buyers, to closing and post-support. The breadth of tasks a sell-side advisor can assist with includes:

  • Analysis of sale alternatives
  • Planning of tax strategies
  • Evaluation of the integrity and sustainability of historical results
  • Financial and transaction modeling
  • Assistance with management presentations
  • Data room preparation
  • Evaluation of potential buyers and bids received
     

What are the advantages of sell-side diligence?

There are several reasons why a company contemplating a sale should consider sell-side diligence. Negative deal outcomes can be mitigated by knowing ahead of time what a buyer could find. By focusing on the areas of most concern to buyers, sell-side diligence affords the seller an opportunity to address them in advance of the sale process.

Another advantage is that sell-side diligence provides information sellers need to answer buyers’ difficult questions concerning such areas as operations, customer concentration, or projections. In fact, some private equity firms are increasingly requiring their portfolio companies to conduct their own internal diligence in advance of an exit. They see sell-side diligence as a way to prepare management teams for the scrutiny associated with the sale process, get them comfortable with the presentation of financial information, and help explain circumstances that could be perceived as flaws to prospective buyers.

When there are numerous prospective buyers, having a consistent set of analyses can significantly reduce the burden on the seller to respond to multiple document requests and redundant queries. Sell-side diligence will likely increase the quality of bids and should help to maximize value of sale, which offsets the costs involved. Also, the seller’s management team will be less distracted by the sales process allowing them to focus on running the business.

Is sell-side due diligence appropriate for carve-out transactions?

Carve-outs are often good candidates for sells-side diligence because of the unique challenges they pose. For example, it might be difficult to determine the true profitability of the business being divested because its’ financial statements are entwined with other divisions. In addition, a buyer is likely to demand clarity on issues such as stand-alone costs, allocated costs, shared services, as well as which systems and resources to move from the corporate parent to the newly independent company. For these reasons, it makes sense to conduct sell-side diligence because it will ultimately help buyers understand the structure of the carve-out and eliminate uncertainties that could lower the value.

Does sell-side diligence replace buy-side diligence?

It is unlikely that sell-side diligence —no matter how thorough — will entirely replace buy-side diligence. However, to the extent that buyers want to rely on the sell-side diligence report, they can potentially reduce their own costs and complete the sale process in a quicker time frame. Thus, the sell-side diligence report will be viewed as a good starting point and a framework for forthcoming discussions. Additionally, to the extent that sell-side diligence reduces the buyers’ need to conduct their own due diligence, there is less of a need to give any one bidder exclusivity and the process can remain highly competitive until the latter phase of the process.

What are the costs and impact on the seller’s management team?

Conducting proper sell-side diligence requires time and money, especially if a company hires a third-party provider. However, sell-side diligence can more than pay for itself by attracting maximum value for the company and allowing management to focus on running the business. Since small and midsize organizations often have lean management teams and bandwidth constraints, they are probably best served by partnering with a sell-side diligence provider who can dive deep into analysis for them and make sure no value is left on the table.

An experienced sell-side diligence provider will make sure that disruption to the management team is minimized, allowing them to remain focused on the business. Not only do they have skills necessary to sift through financial data and other information to develop the diligence report, they can also meet with buyers and answer their questions, so that management can concentrate on running the business. If the sell-side diligence process is managed correctly, there should be no question posed by the buyer that the seller is not prepared to answer.

Conclusion

Buyers want and expect transparency; thus, a fair and balanced sell-side diligence report is a valuable tool for both parties. For the seller, it can provide greater control over the sale process and timing of the sale, while reducing disruptions to the day-to-day business. The proactive due diligence that sellers undertake will help them stand out amongst other sellers, result in fewer surprises during the sales process, and reduce the potential for leaving value on the table. For buyers, sell-side diligence provides greater insight into the organization, which increases their level of trust and confidence in the business and their willingness to move forward with the deal.

Contact

For more information, please contact Ira Weinstein, Co-Managing Principal of CohnReznick’s Baltimore office, at ira.weinstein@cohnreznick.com or 410-783-8328; or Jeremy Swan, principal, Private Equity and Venture Capital Industry Practice, at jeremy.swan@cohnreznick.com or 646-625-5716.


This has been prepared for information purposes and general guidance only and does not constitute professional advice. You should not act upon the information contained in this publication without obtaining specific professional advice. No representation or warranty (express or implied) is made as to the accuracy or completeness of the information contained in this publication, and CohnReznick LLP, its members, employees and agents accept no liability, and disclaim all responsibility, for the consequences of you or anyone else acting, or refraining to act, in reliance on the information contained in this publication or for any decision based on it.

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