Why sell-side diligence is increasingly popular in M&A processes

Business owners and investment bankers increasingly are working in concert on pre-sale due diligence as conditions in the market change M&A realities for sellers. With the cost of capital rising, buyers are applying greater scrutiny as they explore deal possibilities. Without sell-side due diligence, sellers, having signed a letter of intent that marries them to one buyer, could be caught flat footed by something that buyer uncovered in its own diligence. That often gives the buyer leverage in negotiations, which typically means a costly drop in valuation for the seller. So, sellers and their deal teams are adjusting.

“The increase in sell-side diligence frequency stems from sellers becoming smarter,” says Nick Scharfeld, Transaction Advisory Services Professional at Clark Schaefer Hackett.

More astute sellers are looking to identify and head off issues that could become a problem in the sale process. That could include non-recurring revenue or expenses that impact the overall profitability of the business and not reflect its true historical cash flow, customer or vendor concentration issues, historical accounting errors, and improper or omitted tax filings.

Smart Business spoke with Scharfeld about sell-side due diligence, what it entails and why it’s an exercise that greatly benefits sellers.

What’s happening in today’s M&A world that is encouraging more sell-side diligence?

The sell-side due diligence process, at its core, attempts to learn and verify information about a business ahead of its potential sale. Buyers want to be assured of what the business is earning in recurring revenue, spending on expenses, customer and vendor concentration, their supply chain, IT systems, the legality of their HR practices and the abilities of their key personnel.

The market — still feeling the tremors from the pandemic along with a shift in the credit markets, a result of higher interest rates increasing the cost of capital — is driving more scrutiny on deals as buyers seek greater assurance of a return on their investment. Many of those engaging in selling activity understand that the market conditions have changed. If they can prepare for all possible scenarios, they’re more likely to experience a successful sale. Investment bankers and advisers see this trend and are encouraging sellers to engage professionals to do this pre-due diligence activity that explores a company’s financials, environmental aspects, equipment, operations, its IT environment, and HR structure and practices to get ahead of certain issues before taking the company to market.

What should sellers know about the sell-side diligence process?

Sellers should know that the advisers they engage to perform sell-side diligence are on their team. Their objective is to be a trusted business adviser to the business owner and address issues before they become problems, so sellers have a stronger leg to stand on when they’re negotiating with buyers.

Also, diligence is customizable; the due diligence process is not a one-size-fits-all process. A sell-side due diligence engagement can be as simple as examining their reviewed or compiled financials and offering suggestions on issues they see in the market to identifying EBITDA add-back concepts or analyzing the business’ accounting systems.

How much time does sell-side diligence take?

While the diligence timeline is ultimately up to the business owner, it’s driven by the selling process. If the seller has engaged an investment banker, the timeline to take a company to market could be as short as three months, or well over a year. Sell-side due diligence typically precedes going to market by around three to six months. The earlier a seller can engage sell-side advisers to perform diligence the better, as it provides more time to identify and address issues.

Due diligence is very daunting work to someone who hasn’t gone through it at least once. These professionals are going to request a lot of documentation and ask a lot of questions about what they find. A transaction professional, acting as a business adviser, aims to help the business owner obtain the best value for the asset that they’ve spent years building. ●

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Nick Scharfeld

Transaction Advisory Services Professional


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