In today's episode, we are talking about the due diligence process from the perspective of a seller and what to expect.
What's in before an LOI:
Corporate performance
- Market share
- Leadership
- Technical IP
- Brand and intangibles
- Key accounts
Financial performance
- Revenue
- Gross Margin
- EBITDA
- Operating Income
Market conditions
- Market share
- Comparative valuations / deals
- Transaction motives
Once a seller has disclosed with a degree of accuracy these 3 main metrics (with several sub metrics) it is acceptable to expect a letter of intent (LOI) surrounding a combination. In that letter a seller should expect a valuation (at least a range), a methodology for getting to the valuation (so that adjustment to the purchase price are based on actuals vs a change in perceived value levers), a list of terms including the currency (cash, equity, earn-out / or a combination of all) as well as a detailed allocation of where the IP value sits and how it is measured.
Post LOI due diligence:
An extensive list of disclosures, documents, and artifacts that verify the information gathered prior to the execution of an LOI.
Below is a sample of the information gathered post LOI but ahead of definitive agreements (whether asset purchase or stock purchase):
OrganizationArticles of IncorporationCompany bylawsOrganization ChartsCapital structureCertificate of Good Standing from state in which company is incorporatedList of regions in which the company is authorized to do businessList of regions in which the company has employees, contract relationships, leases facilities, or transacts businessList of any names (and documentation) under which the company may operate
Financial ItemsFinancial statements for previous three yearsCompany/Auditor correspondence from previous three yearsCredit reportCapital budgetStrategic planning documentsFinancial schedulesContingent liabilitiesIndebtednessInventoryAccounts receivableAccounts payableDepreciation and amortization procedures and accounting methods in previous three yearsFinancial model containing revenue, fixed and variable expenses, and gross marginsAnalysis of internal control procedures
Physical AssetsListing of fixed assets and their respective locationsAny filings for Uniform Commercial CodeEquipment leasesTransactions relating to major capital equipment in previous three years
Real EstateDetailed listing of business locationsCopies ofreal estate leasesmortgagesdeedstitlessurveyszoning approvalsvariancesuse permits
Intellectual Property (IP)Listing of patents (domestic and foreign) and respective applicationsListing of trademark and trade namesListing of copyrights
Documentationtechnical know-howagreements regarding inventionslicenses or assignments of IPpatent clearance
Listing of any claims or grievances against the company regarding IPEmployeesList of employees and associated employment agreements (noncompetes, nonsolicitations, nondisclosure, etc)Resumes for management and key managerial personnelEmployee handbook outlining key benefits and holiday, vacation, and sick leave policiesPlan outlines of company-sponsored retirement plansDocumentation of any employee issues in previous three years (harassment, discrimination, etc.)Listing of any workers compensation claimsLisitng of unemployment claimsDocumentation of employee stock option and stock purchase plans information
Licenses and PermitsCopies of government licenses, consents, or permitsCorrespondence or documents relating to proceedings of any regulatory agency
Environmental IssuesEnvironmental audits relating to properties leased by the companyListing of hazardous materials used by company in operationsDocumentaiton of company procedures relating to disposal of hazardous materialsListing of environmental permits and licensesCorrespondence relating to EPA or other regulatory agenciesListing of environmental litigation of investigations or possible superfund exposureListing of contingent environmental liabilities or indemnification obligations
TaxesFederal, state, local, and foreign income tax returns for the last three yearsStates sales tax returns for the last three yearsAudit and revenue agency reportsAny tax settlement documents for the last three yearsEmployment tax filings for three yearsExcise tax filings for three yearsAny tax liens
Material ContractsListing of all subsidiary, partnership, or joint venture relationships and obligationsContracts between the Company and any officers, directors, 5-percent shareholders or affiliatesLoan agreements, bank financing arrangements, line of credit, or promissory notes to which the Company is a partySecurity agreements, mortgages, indentures, collateral pledges, and similar agreementsGuaranties to which the company is a partyInstallment sale agreementsDistribution agreements, sales representative agreements, marketing agreements, and supply agreementsLetters of intent, contracts, and closing transcripts from any mergers, acquisitions, or divestitures within last five yearsOptions and stock purchase agreements involving interests in other companies
Product or Service LinesListing of all existing products or services and products or services under developmentCorrespondence and reports related to any regulatory approvals or disapprovals of any company's products or servicesSummary of all complaints or warranty claimsSummary of results of all tests, evaluations, studies, surveys, and other data regarding products or services
Customer InformationListing of the company's twenty largest customers in terms of sales over the previous three year periodSupply or service agreementsDescription or copy of the Company's purchasing policiesDescription or copy of the Company's credit policySchedule of unfilled ordersListing and explanation for any major customers lost over the last two yearsCustomers by ZIP trailing 90 daysAverage Order Value by ZIPDescription of the Company's major competitors
LitigationListing of all pending litigationDescription of any threatened litigationCopies of insurance policiesDocumentation relating to any injunctions, consent decrees, or settlementsListing of unsatisfied judgments
Insurance CoverageListing of the Company's insurance policiesListing of the Company's insurance claims history for past three years.
Service ProvidersListing of all law firms, accounting firms, consulting firms, and similar professionals engaged by the company during past five years
Marketing AwarenessDocumentation of articles and press releases relating to the company within the past three years
In summary:
- Be prepared to share enough information to determine your worth
- Ensure the information is accurate and defendable
- Be prepared to share more information as requested in each category
- Be certain your comfortable with the valuation methodology (this is typically what does not change between LOI, definitives and close)
- Work with an advisor to ensure you are ready and able to support a transaction without interrupting operations and the business overall.
