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Posted: 2010-03-01 / Author: Bob Power

Reversing The Roles - The Seller’s Due Diligence

For many years the due diligence investigation was carried out by the buyer on the seller. However, with the new dynamics in our country, and the substantial increases in the buying of businesses in the SME markets, it is often found that the buyer cannot raise the finances for the purchase, and often knows little about the business he wants to buy.

Perhaps we have gone from “let the buyer beware” to “let the seller be cautious”. This article is from the seller’s perspective. The smart seller should control the process, especially for the following reasons • The seller is disclosing sensitive information to the buyer. • The process takes up much of the seller’s managements time, is the buyer fishing? • The buyer is inclined the drag out the process, find out as much as he can, without an end in sight. It is noted that only 30% of due diligence investigations end up in a transaction, so the usage of management’s time can be wasted, but more importantly the buyer is now in possession of confidential information which could be used to the detriment of the seller. It is also stated that only one per cent of those who wish to enter business actually do so. Therefore before committing himself the seller must- • Set limits for the usage of management’s time and for the completion of the process. • Holding back information (especially off balance sheet matters, legal cases pending, political changes, union issues etc) or camouflage flaws in the businesses make, up until he is satisfied that the buyer is really genuine and his price is within the ambit of the seller’s price. • Be satisfied that the buyer is really a buyer and not acting for the competition. The seller must be satisfied that the reasons for buying the business are within the ball park, such as obtaining growth, eliminating competition, diversifying the scope of activity of his present business etc. • The buyer’s representative has a clearly defined mandate stating that they have the right to negotiate a deal on behalf of the buyer. • Carefully review the buyer’s record and background. Background checks, civil and criminal on the buyer and its owners etc is a wise move (with the consent of the buyer). Regrettably employees can be involved in crime, for themselves or for others, by greed or by threats or as accomplices. • Get references on the buyer. • Check the financial record of the buyer. Is the buyer a legal entity-not a consortium (which is not a legal entity) • Ensure that the proposed transaction is tax advantageous. • Verify the buyer’s ability to pay for the business, a letter of comfort from the financier would be first price, stating 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. Is is prudent not to give away too much information until the letter of comfort is tabled. • In turn the seller must satisfy himself that his business is structured to satisfy a genuine buyer, come with a clean ship to make the business more attractive. Often small businesses have poor admin; the owner breaks the rules (see chapter on bad habits) and takes many chances. If you wish to sell your business at a later dates start putting it in good shape at least 3 years before sale, this can result in a substantial increase in the purchase price. A practice which is gaining a lot of momentum in the US, and coming to SA is for the seller to insist on the sale agreement being signed first, but with a clause for due diligence, but only giving the buyer the right negotiate a reduction in price if he finds things are wrong, but the transaction is still binding on the buyer, not a good practice for a buyer but makes good sense for the seller. What buyers sometimes do not realise is that the seller having built up the business has a passion for it, and doesn’t want the business to be destroyed by someone else, so wants a competent buyer who understands the business. This in important when buying a family business, which is not advised unless you are marrying a daughter or son. The smart seller will get as close as he can to ascertain what the buyer is prepared to pay for the business, and what he is prepared to accept. Only then should he start releasing more information. An important issue is that the seller must when allowing the process to commence, ensure that he works on the need to know basis, and staff are not aware of the possible deal. At the appropriate time they must be advised, but as 70% of investigations fail-hold back for as long as possible. Staff panic when they know a deal may materialise and they may be fired, so they can destroy a deal. The sale of the business is usually the best exit policy for the seller, so he will want to get the best deal possible he can-go for it.
Bob Power Corporate Consultants

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