Reverse Due Diligence in M&A Transactions - [Ultimate Guide]
When it comes to mergers and acquisitions, you seldom think about turning the tables on yourself and becoming the prospective buyer with tens of potential questions or concerns.
If you were the person buying your company, would it be attractive enough? Are there any red flags that would discourage you?
To answer such questions, you would have to do reverse due diligence. But what is it? How can it protect your business goals?
Remaining objective during the process can be difficult, which makes working with an external M&A team important.
When you connect with Exitwise, we’ll help you form a dream team of accountants, business appraisers, wealth advisors, and investment bankers. The experts will examine your company’s strengths, weaknesses, and opportunities to protect your business goals.
What Does Reverse Due Diligence Mean in an M&A Transactions?
Also called sell-side due diligence, reverse due diligence is a close examination of your own company as if you were the buyer. The process assesses your company's overall health and value to gauge its strengths and weaknesses, especially close to a sale.
Types of Reverse Due Diligence
You can delve deep into the following types of reverse diligence:
Financial due diligence: Review your financial statements, accounting procedures, balance sheets, and quality of earnings to assess your potential risks, profitability, and financial health.
Commercial or business due diligence: Evaluate your company's main business, competitors, customer base, exploitable market gaps, and positioning. Such diligence is essential if your projected future revenues are crucial to selling your company.
Legal due diligence: Shield your buyer from lawsuits arising from existing contractual obligations, possible liabilities, threatened legal proceedings, or government litigations.
Tax due diligence: Review your tax returns for the last 3-5 years. Do you have any historical tax liabilities? Are there tax carryforwards the buyer may benefit from?
Human resources due diligence: Evaluate your employment contracts, turnkey employees, human resource policies, and the general workforce.
Operational due diligence: Check for operational inefficiencies in your supply chain, IT infrastructure, sales system, organizational structure, or production processes.
Environmental due diligence: Check for potential environmental concerns about complying with environmental regulations, practices, or permits.
Reverse Due Diligence vs. Traditional Due Diligence
Traditionally, potential buyers do buy-side due diligence to assess the overall health of a company they are interested in. In recent times, sellers conduct reverse due diligence to evaluate their company's health and attractiveness to potential buyers.
One crucial aspect common to both reverse and traditional due diligence is the inclusion of soft due diligence alongside hard due diligence.
Soft due diligence considers qualitative issues like human resources, customer base loyalty, quality of management, and company culture.
Traditional due diligence usually focuses on hard aspects like potential benefits, liabilities, costs, and current assets.
Why is Reverse Due Diligence Necessary?
Reverse due diligence is necessary for the following reasons:
You can gauge your company's financial strength to set up the right sale price.
You can see if your business would appeal to prospective buyers.
You can maximize your company's sale price. When you validate the quality of your earnings, justify your forecasts, and address potential concerns, you limit the buyer's capacity to renegotiate the sale price.
You'll minimize surprises. When you disclose any concerns in advance, your transparency improves your credibility and makes potential buyers more confident, especially if you show the remedies you set up.
Sharing information first puts you in a power position during negotiations.
Key Stakeholders in Reverse Due Diligence
The reverse due diligence process involves key stakeholders, such as business or corporate lawyers, accountants, business brokers, and tax experts.
While you can use your company's internal team for reverse due diligence, it’s best to use a third party for absolute objectivity.
You can talk to us at Exitwise to help you hire and manage a reverse due diligence team comprising M&A attorneys, tax experts, wealth managers, investment brokers, and accountants. The team will protect your business goals and ensure a smooth, maximum-value business exit.
Reverse Due Diligence Checklist
Since reverse due diligence is extensive, you'll want a simple checklist to guide you so you don't miss any crucial part. Here's a quick checklist to follow.
1. General Corporate Information Documents
Have the following documents ready to show the structure of your company.
Organization documents as applicable, including:
Organizational chart
List of locations you are authorized to operate in
Certificate of Good Standing
Restructuring documents, if any
List of partnerships
Corporate structure documents
Article of incorporation.
Business documents, including:
Annual reports for the last 3-5 years
Business plans
Corporate bylaws.
2. Financial and Accounting Documents
Prepare the following to show your long-run profitability.
Financial information, including:
Income statements for the last 2-5 years
Bank statements for your company accounts
Equity and market capitalization documents. Include balance sheets, deferred revenue, cash flow statements, and any stock purchase agreements.
Budgets, including capital and operating budgets
General ledger, showing accounts receivable and accounts payable
3-5 years of unaudited and audited financial statements
Credit information, including loans and lines of credit.
Tax details, including:
Government audits
Tax returns and tax structure for the last three years
Property tax statements, if any
Tax benefits, tax sharing, or tax transfer agreements.
3. Human Resource Information
Prepare HR details to show integration opportunities and noteworthy talents.
Employee information, including:
Curriculum vitae of turnkey employees
Current employees and their demographics
Employee benefits.
HR contracts, including:
Employment contracts
Non-solicitation, non-compete, and non-disclosure agreements
HR practices and policies
Payroll information, pension plans, and deferred employee compensation
Labor disputes
Employee competence and skills assessments.
4. Legal Information
Prepare legal information to mitigate litigation risks.
Legal details such as:
Ended, ongoing, threatened, or pending litigations against your company or those you have initiated
Governmental investigations, if any.
Material contracts and agreements, including:
Licensing and franchise agreements
Indemnification agreements
Correspondence between your company's auditors and attorneys
Business consulting agreements and contracts.
Loan details such as:
List of your lenders, banks, or creditors
Outstanding debt, guarantees, or indemnification documents
Copies of leases, security agreements, letters of credit, or mortgages.
5. Sales and Marketing Information
You'll need the following to show your company can realize the profits you forecast.
Customer information, including:
Customer analysis
Your best current and past customers and their revenue records
Copies of customer contracts
Warranty claims.
Product information such as:
Sales analytics
Advertising materials like press releases, television ads, and brochures
List of current business products and services
List of unreleased business products and services.
Marketing information such as:
Market research
Top resellers, distributors, or suppliers
Marketing plans and agreements.
6. Assets Information
List your physical and intangible assets to help determine your sale value.
Tangible company property information such as:
List of owned and leased properties, fixed assets, and real estate. Indicate their location, date of acquiry, and more.
Copies of your inventory at the end of your fiscal month and year
Property deeds.
Intangible company property such as:
Patent applications, trade secrets, and granted patents
Copies of collaboration files, licensing, and research and development related to patents
Material and unregistered trademarks, copyrights, and trade names
List of your company's social media accounts and websites.
How to Conduct Effective Reverse Due Diligence
You have two options—use your internal audit team or hire impartial third-party professionals.
Regardless of the method, the following steps ensure your success:
Define the scope and objectives of your reverse due diligence to focus on the most crucial aspects.
Think like a buyer so you can remove any blinders that would prevent you from finding faults in your company.
Create a checklist based on the scope.
Conduct the examination, striking completed items off the checklist.
Identify opportunities and risks. Specify the risks that may break a purchase offer. Outline the opportunities for maximizing the value of your business.
Act on the findings and recommendations of the diligence team.
Repeat the process, if necessary, to ensure a continuous state of being always ready to sell your company.
Add the diligence report to the online data room, including any remedies you've put in place for issues prospective buyers may encounter.
To maintain objectivity and credibility, it's best to outsource the entire reverse due diligence process to a third party.
We can help you find and manage a holistic team that will conduct reverse due diligence as if they were performing it for an interested buyer, which can help uncover critical aspects that can lead to a higher sale price.
Strategies for Presenting Your Company to Potential Buyers
One way to present your company to potential buyers is to notify competitors that it is for sale.
Alternatively, market your business online on social media, your company website, and industry and business forums.
Let potential buyers know you have expedited the process by conducting reverse due diligence and that you’ll share the results in the online data room after a non-disclosure agreement.
The best strategy is to let the professional third party you hired present your company. They already have a large pool of prospective buyers. They can also design appropriate negotiation strategies based on their extensive M&A experience.
Pitfalls in Reverse Due Diligence and Ways to Avoid Them
Seeing that reverse due diligence involves scrutinizing your own company, you may experience pitfalls that could lower the chances of a successful business sale.
You might take the results of reverse diligence personally and go on the defensive. Instead, the report guides you through the various issues you should fix. You should start applying applicable remedies right away to increase your company's value.
You might have human bias, hence interpreting information subjectively. Instead, hire impartial third-party professionals to maintain objectivity during the process and in the report.
You might lose focus as the information in the process can be overwhelming. To remedy this, rely on the expertise and judgment of industry experts to obtain a complete perspective.
You might be tempted to keep potential issues from your prospective buyers. Such a lack of transparency could ruin a sale if the buyer discovers you knew these issues beforehand.
Frequently Asked Questions (FAQs)
Here are some questions an owner may have on reverse due diligence.
How Does Reverse Due Diligence Impact Mergers and Acquisitions?
Reverse due diligence helps maximize a company's value. You can find opportunities to improve your business and raise its value. Additionally, addressing potential buyers' concerns in advance can reduce the buyers' ability to renegotiate the sale terms or sale price.
Reverse diligence also smoothens the sales process. The buyer conducts their due diligence faster and compares it with your own, leading to a shorter sale time.
What Role Do Financial Advisors Play in Reverse Due Diligence?
Financial advisors prepare a detailed report that they present to interested buyers to show that an objective third party has evaluated the company on sale. You can win the confidence of prospective buyers this way.
Financial advisors also formulate favorable negotiation strategies in light of the potential issues they discover during reverse due diligence.
You can enjoy the services of the best financial advisors in your industry when you work with us to hire and manage a reverse due diligence team that will provide an honest evaluation and report.
How Can Reverse Due Diligence Influence Investment Decisions?
Reverse due diligence can make buyers trust you more once they see your initiative, honesty, and transparency. They may pay your asking price without extensive negotiations.
Potential investors can also finalize the deal sooner because your reverse diligence reduces the time they need to conduct their own investigations.
What Are the Legal Implications of Reverse Due Diligence?
Reverse due diligence can have both positive and negative legal implications.
If you find a significant issue and fail to rectify it or report it to the buyer, they might later sue you for dishonesty or lack of transparency.
On a positive note, reverse diligence can save you if the buyer doesn't do any or does due diligence poorly and later faces massive challenges. If these stem from an issue you disclosed to them and agreed upon, you'll be on the safer side.
Conclusion
You now know the essentials of reverse due diligence, what it is, and how it can protect your business goals.
If you would like to sell your company soon, contact Exitwise right away. We’ll help you find and hire an M&A team not only for objective reverse due diligence but also for a maximum-value sale.
