THE SELLER’S DUE DILIGENCE
Historically, due diligence investigations were carried out by the buyer on the seller, however, times they are a changing and perhaps it is time to embrace a philosophy of “let the seller be cautious” along with “let the buyer beware”.
By Bob Power
Resulting from the changing dynamics in our country and the substantial increase in the number of SME businesses being bought and sold, it increasingly occurs that the buyer is unable to raise the necessary funds to conclude the transaction and/or knows very little about the business he wants to buy.
In embracing the “let the seller be cautious” philosophy it is advisable for a seller to exercise control during the transaction and due diligence investigation for the following reasons:
• The seller is disclosing sensitive information to the buyer. What if the buyer is fishing?
• The process takes up much of the seller’s management’s time.
• With no established date for completion the buyer may drag the process out indefinitely.
As only around 30 percent of due diligence investigations result in a transaction, not only is this a potential waste of management’s time, the buyer also walks away with confidential information pertaining to the seller’s business.
Before committing to the process the seller should -
• Set limits for the usage of management’s time and the completion of the process.
• Be satisfied that the buyer is genuine and the offer price is within the ambit of his requirements. It is advisable to hold back information pertaining to off-balance sheet matters such as legal cases pending, political changes, union issues, economic downturn and contract cancellations.
• Be satisfied that the reasons for buying the business are within the ballpark, such as obtaining growth, eliminating competition, diversifying the scope of activity of his present business and that the buyer is not acting for the competition.
• Ensure that the buyer’s representative has a clearly defined mandate with the right to negotiate on behalf of the buyer.
• Carefully review the buyer’s background and record. It is advisable to, with the consent of the buyer, conduct civil and criminal background checks on the buyer and its owners where applicable.
• Obtain references on the buyer.
• Verify the financial records of the buyer and ensure that the buyer is a legal entity. A consortium, for example, is not a legal entity.
• Ensure that the proposed transaction is tax advantageous.
• Verify the buyer’s ability to pay for the business. First prize would be a letter of comfort from the financier, confirming that if a deal transpires and the financier is happy with the terms of the transaction, money to cover the purchase price will be available.
• In turn the seller must satisfy himself that his business is structured to satisfy a genuine buyer. Often, small businesses do not adhere to the rules of corporate governance; they have poor admin and the owner breaks the rules and takes chances. If you wish to eventually sell your business, start cleaning ship at least a year before as this can substantially increase the purchase price.
With more and more sellers taking the initiative and setting the pace, a new practice that is gaining momentum in the United States and slowly being introduced to the South African market, is for the seller to insist that the sale agreement be signed first. Such an agreement will include a clause allowing for a due diligence to be conducted by the buyer and gives the buyer the right to renegotiate the purchase price based on “problems” found during the course of the due diligence investigation. The transaction, however, is still binding on the buyer and while this is perhaps not good practice from the buyer’s perspective, it makes good sense for the seller.
Buyers do not necessarily realise that the seller, having built the business from scratch, has a passion for it and does not want it destroyed by someone else. He wants a competent buyer who understands the business.
During sale and purchase negotiations sellers are strongly advised to proceed on a need to know basis.
Remember that 70 percent of sale and purchase investigations fail, and making staff aware of a transaction that may never transpire may result in unnecessary panic with the potential to derail a transaction.
Selling his business is usually the seller’s best exit policy, so negotiating the best deal possible is critical. The smart seller will to the best of his ability ascertain what the buyer is prepared to pay for the business and what he himself is prepared to accept. Only then should he start releasing more information.
www.powerconsulting.co.za
rpower@mweb.co.za
+27 11 880 7850
By Bob Power
Resulting from the changing dynamics in our country and the substantial increase in the number of SME businesses being bought and sold, it increasingly occurs that the buyer is unable to raise the necessary funds to conclude the transaction and/or knows very little about the business he wants to buy.
In embracing the “let the seller be cautious” philosophy it is advisable for a seller to exercise control during the transaction and due diligence investigation for the following reasons:
• The seller is disclosing sensitive information to the buyer. What if the buyer is fishing?
• The process takes up much of the seller’s management’s time.
• With no established date for completion the buyer may drag the process out indefinitely.
As only around 30 percent of due diligence investigations result in a transaction, not only is this a potential waste of management’s time, the buyer also walks away with confidential information pertaining to the seller’s business.
Before committing to the process the seller should -
• Set limits for the usage of management’s time and the completion of the process.
• Be satisfied that the buyer is genuine and the offer price is within the ambit of his requirements. It is advisable to hold back information pertaining to off-balance sheet matters such as legal cases pending, political changes, union issues, economic downturn and contract cancellations.
• Be satisfied that the reasons for buying the business are within the ballpark, such as obtaining growth, eliminating competition, diversifying the scope of activity of his present business and that the buyer is not acting for the competition.
• Ensure that the buyer’s representative has a clearly defined mandate with the right to negotiate on behalf of the buyer.
• Carefully review the buyer’s background and record. It is advisable to, with the consent of the buyer, conduct civil and criminal background checks on the buyer and its owners where applicable.
• Obtain references on the buyer.
• Verify the financial records of the buyer and ensure that the buyer is a legal entity. A consortium, for example, is not a legal entity.
• Ensure that the proposed transaction is tax advantageous.
• Verify the buyer’s ability to pay for the business. First prize would be a letter of comfort from the financier, confirming that if a deal transpires and the financier is happy with the terms of the transaction, money to cover the purchase price will be available.
• In turn the seller must satisfy himself that his business is structured to satisfy a genuine buyer. Often, small businesses do not adhere to the rules of corporate governance; they have poor admin and the owner breaks the rules and takes chances. If you wish to eventually sell your business, start cleaning ship at least a year before as this can substantially increase the purchase price.
With more and more sellers taking the initiative and setting the pace, a new practice that is gaining momentum in the United States and slowly being introduced to the South African market, is for the seller to insist that the sale agreement be signed first. Such an agreement will include a clause allowing for a due diligence to be conducted by the buyer and gives the buyer the right to renegotiate the purchase price based on “problems” found during the course of the due diligence investigation. The transaction, however, is still binding on the buyer and while this is perhaps not good practice from the buyer’s perspective, it makes good sense for the seller.
Buyers do not necessarily realise that the seller, having built the business from scratch, has a passion for it and does not want it destroyed by someone else. He wants a competent buyer who understands the business.
During sale and purchase negotiations sellers are strongly advised to proceed on a need to know basis.
Remember that 70 percent of sale and purchase investigations fail, and making staff aware of a transaction that may never transpire may result in unnecessary panic with the potential to derail a transaction.
Selling his business is usually the seller’s best exit policy, so negotiating the best deal possible is critical. The smart seller will to the best of his ability ascertain what the buyer is prepared to pay for the business and what he himself is prepared to accept. Only then should he start releasing more information.
www.powerconsulting.co.za
rpower@mweb.co.za
+27 11 880 7850
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