“I would like to sell my business but I would like to minimise my cost exposure until I know what the offers look like.”
The thoughts posed above are invariably echoed by many vendors as they consider embarking on a business sale process. Fortunately, the bulk of the costs of selling a business are often incurred when there is a proceedable offer on the table. On the other hand, Vendor Due Diligence, although optional, can represent a cost commitment earlier in a sales process. However, the value of such an exercise should not be ignored.
Vendor Financial Due Diligence, as the name suggests, is an independent/objective due diligence exercise commissioned by the vendor (rather than buyer) on the financial affairs of the business it is looking to sell. It is normally undertaken where there is a sale process whereby multiple parties are being invited to bid to acquire or invest in the business. VDD seeks to cover all of the areas that the prospective buyer pool might have wished to have covered if they undertook buyside due diligence themselves.
So why not just let the buyer commission the due diligence and pay for it themselves? The answer to this question can be summarised under three areas which mutually support value: (a) foresight; (b) support for value drivers; and (c) competitive tension.
A VDD process will almost always commence before a sale process is launched.
sell-side advisor wants to (a) make sure that the financials it is presenting to the market will be in line with that ultimately presented in the VDD report; and (b) that any red flags are known about before going to market. This process adds credibility to the numbers presented and helps to avoid any uncovered issues jeopardising the deal, impacting valuation and/or distracting negotiations with the buyer. Clearly, having foresight over any such issues enables a seller to either resolve them or to think about how they could be positioned in the sale process, thus helping to protect value.
Support for value drivers
In the Information Memorandum (IM) that is sent to prospective bidders, a sell-side advisor will want to highlight the critical success factors/positive value drivers of the business, particularly those which show the business to have sustainable EBITDA with good growth prospects. The scope of a VDD can be designed to include analysis which credibly evidences these value drivers, adding credence to the IM, increasing the buyers’ confidence in the numbers; and thus helping to support the valuation of the business.
Once the sell-side advisor has drawn up a shortlist following first round offers for the business, the VDD report (assuming one has been produced), is then typically issued to those parties to read and consider in conjunction with making their second-round bids (during this time they would also usually have a short meeting with the DD provider to discuss the report). This puts all shortlisted potential buyers on a level playing field – they’ve all seen the same due diligence report. Their second-round bids would be expected to be on the basis that due diligence has been performed and therefore any buyside due diligence during an exclusivity period would be limited. This streamlines the transaction process and limits the opportunity for a prospective buyer to use the exclusivity period to conduct further due diligence, potentially leading to price chipping.
For all of the reasons above, VDD needs to be independent and credible; and therefore the fees for VDD cannot be contingent on a successful deal outcome, thus creating an initial cost exposure for a prospective seller. However, the costs of a VDD process are very often significantly outweighed by the value it can add.