We have all heard of due diligence, and it is accepted as a necessary step for buyers when they are investigating an acquisition or merger. Sell side due diligence for accounting practice principals is rarely addressed.
Should sellers be conducting due diligence on the buyer? Yes, is the short answer. This article will discuss some of the reasons why a seller should conduct due diligence. Discovering the nature of the buyer, the financial position of the buyer, the buyer’s activity level and experience in the merger and acquisition space, and creditworthiness are all important variables for the sell-side of the transaction.
Discovering the Nature of the Buyer is an Important Step Before Signing an LOI
There are many different buyer types. Private Equity has moved aggressively into the accounting space and now comprise a sizable portion of the buyer pool. Wealth management and other strategic buyers are also a significant portion of the buyer pool. There are aggregators as well that play the arbitrage game. There are also the more traditional buyers who are just growing through acquisition or moving from an employee position into entrepreneurship.
Discovering the type of buyer will help sell side principals to discover the buying entity’s intent, which will help with negotiation. Most sellers care about their clients and their employees and understanding the intent of the buyer can really help them in selecting the right buyer for their firm. These can usually be determined by simply asking questions in the first couple of meetings and doing some online research.
The Financial Strength of a Buyer Determines the Likelihood of Repayment
Most deals today over $500,000 involve financing and in most transactions, there is a level of seller financing involved. If the seller is extending credit and has any portion of the deal that is variable, a look at the financial strength of the buyer is a needed due diligence step for sell-side principals. Requesting corporate financials and a personal financial statement from the buyer principals is a good first step before entering into any binding agreement.
There may be pushback on personal financial statements from large buying entities but ask for it anyway. Validating financial strength and liquidity are things that every bank will want to know before entering a credit facility with a buyer, so a selling principal should as well. Banks will want more than one repayment source with the primary repayment coming from the cash flows of the purchased firm.
But understanding the financial strength and the liquidity position is imperative to ensure they have enough for the bank injection and working capital until the purchased firm is fully operations and generating its own repayment cash flow. Understanding the financial strength will help you determine repay capability if things do not go well. We all hope they go well but looking at worst case scenarios is important as a just in case. You can rely on banks to do some of this work if there is external financing in play.
The Credit Worthiness is Important If there is No Bank Financing Involved
If a traditional bank is providing the gap financing between the buyer injection and the seller carryback, checking a buyer’s credit is not particularly important because the bank will do the credit check and background search for you. However, if there is no external financing a seller should get a credit report from the buyer or get authorization to pull one themselves in addition to a background check.
In many cases, we have seen derogatory information on a buyer or partner that was hidden by the primary borrower and lead principal on the buying side of the equation. If you are extending credit or taking an earnout without bank financing, there are extra steps you should consider. Pulling credit and background checks are highly recommended as a measure of the sell-side due diligence.
Experience Level of a Buyer and How Active They are in Mergers and Acquisitions
There are a number of reasons for selling principals to know this information. If this is their first acquisition, there is so much a buyer does not know yet. On the other hand, if they are actively pursuing multiple deals every year it is also important to know. Active buyers may have numerous LOIs to other sellers before they even talk to your firm. Knowing their experience level and how many deals they are currently chasing will help you make decisions on whether to include them seriously in the conversation.
Selecting a buyer that has 3-5 offers already out there adds significant risk. They may be working through your opportunity as a back-up to several other opportunities. Knowing this information up front may save you from providing them with exclusivity or may you respond to their exclusivity request with an exclusivity request of your own.
Some level of sell-side due diligence is needed in almost every deal. It will help with determining the probability of receiving full payment. It will help you with negotiations and it will help you save time.
There is nothing more frustrating than going down the road with someone and spending 120 days or more putting the deal together, only to find out about a credential or cash flow problem or finding they are not bankable.
Berkshire Business Sales & Acquisitions specializes in accounting practice and CPA firm sales. We represent the seller in these transactions and our fiduciary is to the selling principals. We spend every day entertaining new buyers for the benefit of our selling principal’s needs. If you need help taking your firm to market, please reach out to Ryan Gipple at 602-614-3583.
