Avoiding nasty surprises is key during the due diligence process.
Succession Planning for many business owners means selling the business onto a third party. Ideally we are involved at an early stage, so we can help the business owner negotiate a favourable deal structure, assist with preparing the business for the sale and with collating due diligence information required by the buyer.
Other times business owners come to us with a buyer lined up, so we work with them to ensure the sale progresses smoothly and they achieve the exit terms and value they want. Some buyers may be aggressive on the deal process, terms and price, so it really does pay to have the right team on your side to fight your corner.
It is never too early to start thinking about selling your business, getting an accurate valuation and using the time ahead of the sale to tidy up matters to make the company as profitable as possible in order to achieve an attractive offer.
The sale typically progresses with negotiations on price, but that can be hard if the seller has a particular number in mind and the buyer makes a lower offer. Each party both can do their own calculations based on the information available and I always advise sellers to do their own valuation, just in case a buyer does come up with a much lower figure or wants to negotiate a substantial sum before completion.
The initial purchase price is often stated on a ‘cash-free debt-free’ basis. This means that cash in the business is retained by the seller and all debt is repaid by the seller on completion.
This helps to protect the incoming buyers from needing to inject cash into the business on or shortly after completion, helps establish normalised working capital levels and sets out what happens if it is not met.
Following the completion of the transaction it is usually the responsibility of the seller to produce completion accounts. At this point, the actual working capital level and net cash/ debt on the date of completion will be known and compared to the agreed target and a purchase price adjustment will be made.
An alternative to this is the locked-box mechanism which is becoming more common. The key difference is that the final adjustments to the amount paid for a business are applied using a balance sheet at a date prior to completion termed the locked-box balance sheet. The buyer will want to protect themselves from cash or other assets being extracted from the business between the locked-box date and completion and protection from this leakage is built into the Sale and Purchase Agreement.
The locked-box mechanism works well where the buyer has carried out sufficient due diligence on the locked-box balance sheet as there is no adjustment mechanism on completion and gives both parties certainty over total consideration.
Not all business sales go smoothly and there may be several issues which can arise during the due diligence process. Shareholders often underestimate the volume of information that is required for tax and financial due diligence. It takes time to collate this and depending on the systems in place some information may not be readily available. Often employees are not aware of the transaction, and it is the responsibility of the selling shareholders to collate all due diligence information and respond to questions alongside running the business as normal.
Whatever the stage in your business life cycle it is always good to have the end in sight and know what you want from the business when you decide to retire or pursue new ventures. Contact Tania Phillips, Associate Director in the Corporate Finance Team at Mercer & Hole for further advice and guidance.
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