Whether you seek third party investment in your company or want to sell it, your business will most likely undergo a period between agreeing on a term sheet or letter of intent and signing a definitive agreement – the due diligence phase. Many companies dread this, but as transactional lawyers who frequently represent companies raising investment capital or participating in acquisition transactions, we have noticed a few key concepts embraced by our more successful clients.
Rather than resisting due diligence by the investor or buyer, these clients understand its purpose and use it as an opportunity to shorten the time of the transaction process and sometimes increase (or at least stave off decreases to) value.
Understand the Process
The conventional wisdom views due diligence as the collection, organization and review of information about your business by an investor or buyer that wants to understand the business and growth opportunities, but also find problems or concerns. We encourage a more multi-dimensional view – due diligence information usually populates disclosure schedules used in a definitive agreement, and it can also create the integration plan’s post-closing milestones (often a key interest if contingent consideration depends on integration success).
But time is not your friend. Delays create stress from cash strain, information leaks, nervous customers or employees. Though sellers like to blame delays on the due diligence process itself, the more frequent cause is an inability to gather requested material quickly. That failure sometimes results from not involving the right people for particular topics (e.g., employee benefits) or waiting for a request before even gathering materials.
Understand and anticipate, rather than fight, the process. Tailor your response to fit your goals and objectives. For example, if selling your business to a competitor, be up front that certain sensitive information (e.g., customer lists) will be held back until closer to signing of a definitive document when greater deal certainty exists.
Every due diligence process covers standard topics. Effective preparation requires a team organized before the process begins. That team reviews a customary diligence request list, gathers relevant materials, and reviews them to anticipate issues of possible concern. If issues are identified, sophisticated companies disclose them early on along with thoughtful solutions.
Failure to jumpstart the process in the hopes that a shortened or “lighter” diligence process will result rarely works. Investors and buyers take the time needed to conduct their process and, in some cases, may walk away due to delay or unhelpful responses.
Comprehensive responses are not automatically onerous. For example, the size of your company may mean that a customary request to see all contracts (with customers, etc.) requires pulling hundreds of documents that will not be meaningfully reviewed.
It may be more effective to respond with a list of key data concerning your contracts and identification of key contracts or threshold amounts that permit gathering a more manageable volume of material.
Comprehensive responses can be nuanced. For example, investigation into intellectual property typically boils down to ownership questions – so well-organized data that identifies all current and former employees and consultants, and attaches the contracts with the intellectual property protection provisions that each signed, will impress an investor or buyer with the discipline of such protection. Similarly, a list of all third party and open source software used in the business, along with a copy of the relevant license agreements, anticipates concerns about proprietary rights and recourse in the event of an infringement claim.
In Conclusion: Don’t Be Afraid
Companies that resist due diligence miss a key opportunity to accelerate deal momentum and show off. A well-run due diligence process strengthens confidence, and each question permits you to demonstrate the strength of your company and team.
So if an investment in or acquisition of your business looms, embrace the inevitable due diligence process to enhance your value rather than cause you headaches.
Gian Brown, of counsel and David Garcia, partner, Holland & Hart