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Navigating Sell-Side Due Diligence

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Sell-side Due diligence by Craig Clay – full bio at bottom of the post

Selling your company may be the most important milestone in your professional career. The sale process can be tedious and complicated with potential buyers investigating all aspects of your business. Reviewing your financials, compliance documents, organizational structure and tax positions in the early stages of going to market allows plenty of time for remediation of any uncovered issues, which can maximize the transaction value and accelerate the sale process. Companies that undertake these sell-side due diligence reviews before going to market have a much better chance of impressing buyers, increasing their sale price and reducing the potential delays during a transaction.

In educating executives on the importance of sell-side due diligence, we have discovered that tax issues are priority number one. It’s no surprise given the uncertain and changing tax environment.

One of the most difficult aspects of understanding a target’s tax situation is accounting for future events that could affect the tax liability. The tax position has to be studied, as changes in policy may make for a less attractive asset, and may even generate a request for compensation.

Beyond the Financials

The core of any sell-side diligence is a company’s financial disclosures.  However, key signs of corporate health – or disorder – can also be found outside the financials. Among these elements, material contracts and customer concentration are critical.

Companies should carefully examine a company’s material contracts on the sell-side in order to optimize the deal price. You can enhance value by reviewing the customer concentration and outstanding contracts, as well as the company’s competitors.

Another aspect beyond the financials is corporate culture. Lessons can be learned from the infamous deal between Sprint and Nextel in 2005. Sprint, which acquired Nextel for $35 billion, had a more formal company culture that was based on performance metrics and top-down control, while Nextel had a more flexible and enterprising work culture. The stark differences contributed to disagreements between the management teams and by 2008, Sprint wrote down 80 percent of Nextel’s value. To avoid company culture clashes, the selling company can include a survey of personnel on culture and values as a part of its due diligence.

Private Equity vs. Strategics

When polled by Mergermarket on the relative importance of sell-side diligence for private equity vs. corporate acquirers, 40 percent said it is more valued on the PE side, while only 22 percent said corporates get more use out of it. The remainder saw no difference.

Respondents’ opinions can be explained in the nature of private equity in the modern age. PE firms have mushroomed in recent years – in Q3 2016, a record 1,807 funds were in the market seeking capital, while dry powder also stood at a record high of $839 billion. As a result, it’s becoming increasingly difficult for funds to back worthwhile deals. This makes having a sell-side due diligence available a potentially valuable time saver.

It’s not uncommon for a PE firm to have many targets, and due diligence on all the targets is a long and costly process, so sell-side due diligence reports can be extremely helpful. PE firms rely more on sell-side due diligence because it makes the process of investing easier for them and helps them more quickly understand how a company would fit into their portfolio.

Just as PE firms are usually targeting multiple businesses at once, sellers usually have a number of suitors in an auction. Is it worth it for the seller to customize the sell-side diligence? There’s no one-size fits all approach. On one hand, customizing the report could ultimately increase the potential buyer base and acquisition price. But on the other, it could be waste of resources because it increases costs and because there’s no guarantee of a higher return. Sellers must decide whether this is worthwhile based on the specifics of each situation.

The Right Timing and Team

The sell-side diligence process can start when you’re drafting the Confidential Information Memorandum, when a decision to sell is reached or only during the negotiation process. But it should be early, allowing a business to make important changes to eliminate any risks or oversights that are identified.

The earlier you start your sell-side due diligence, the more time you allow yourself to rectify any potential value-critical issues uncovered by the process.

About the Author

Craig Clay, President of Global Capital Markets

Craig Clay has been with Donnelley Financial Solutions for 20 years and is the president of Global Capital Markets. Craig’s responsibilities include customer satisfaction and retention, owning the vision, strategy and goals for the Capital Markets and Global outsourcing business and aligning regional market strategies with the overall strategy. He is also responsible for delivering superior service distinctiveness to customers and delivery technology solutions to answer client needs. Craig has demonstrated leadership, a customer focus, and commitment to results throughout his career with Donnelley and its corporate predecessor, RR Donnelley.

Prior to joining Donnelley Financial Solutions, Craig was with American Eurocopter a subsidiary of Aerospatiale. Craig received a BBA in Finance and International Business from Baylor University and MBA from Southern Methodist University.

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