By Ron Rauch, CPA
Homer Simpson once famously said, “Three little sentences will get you through life. Number one: ‘Cover for me!’ Number two: ‘Oh, good idea, Boss!’ Number three: ‘It was like that when I got here’.” It’s worth noting, however, that Homer often cited number three when he was caught by Marge in some mess of his own making!
Buyer Due Diligence
Not surprisingly, “it was like that when I got here” is also sometimes heard in the world of business transition.
When a buyer’s due diligence identifies deep, sometimes hidden issues, such as issues that affect employee morale or customer dissatisfaction, the seller may be faced with the unwanted reality of needing to sell their business for less than they hoped. Buy-side due diligence is designed to find problems that sellers may not appreciate as significant, but which buyers can use as negotiation points.
Even in situations where business control is being transitioned from one generation to the next, the younger generation may not understand the nuances of key vendor relationships, or how the Company navigates regulatory issues. Owners can unwittingly saddle successors with issues that should have been dealt with earlier.
Using Due Diligence to Expose Hidden Issues
Certainly, it may be possible to overcome these issues, at least partially, with an orderly over-lap in the transition of management. That said, not all sellers want to stay involved after their business is sold. In these instances, the buyer is left with the grim reality of a negative situation where all she can say is, “It was like that when I got here.”
While due diligence cannot uncover all issues – positive or negative – buyers want to know that due diligence procedures took place. These procedures should include a comprehensive review of the business’ value drivers.
Value Drivers are the operating characteristics that underlie every business and form a crucial part of what gets transitioned from seller to buyer. Buyers can use this information to their advantage in negotiating the terms of the deal, as well as in prioritizing future plans for growth. Learn more about the drivers in the video below:
How Due Diligence Benefits the Seller
The flip side of this issue, of course, involves the seller. Sellers often have both the best and worst views of their business. Founders, especially, can have difficulty viewing their business objectively.
Typically, a founder builds their business with themselves at the helm. While this means that a founder can navigate almost any circumstance, it does not mean their business is well tuned, or that someone could step into their role without missing a beat.
To combat the above situation, it’s best to run your business as though it’s always ready to be sold – even if you are not planning to sell it. Here’s an analogy that shows why this is a smart approach: My house is not for sale, but I aspire to keep it in a condition that would provoke a would-be buyer to offer an unsolicited price that I could not refuse. Why not run a business that way?
Operating a business that is well-tuned is much like driving a fine car. Or living in a beautifully maintained home. Its condition allows you to know how it will operate and allows you to assure potential buyers of its worth.
It makes sense that a seller can become exhausted from years of building a business. They may feel that they do not have the energy to tune up the business before a transition – even though they may be leaving good money on the table.
However, those who have the time and the willingness to view their business objectively, and make improvements, can maximize the financial return. They also benefit from walking away from their sale knowing they’ve provided the buyer with a sound purchase.
Due Diligence in Action
I was once accompanying a client on a tour of his new business. On the tour, I noticed that the plant was bustling with activity – employees would smile and say ‘hello’ as we walked by. It was already 15 minutes past quitting time, but the employees were still working. The owner said that the employees wanted to meet the goals for the day and were willing to put in the extra effort to do so.
The client was feeling satisfied: the purchase was complete, and the transition had gone smoothly after a good negotiation and thorough due diligence process. I asked the owner what changes he had made since taking over the business. He replied, “Not much, it was like that when I got here.”
Questions about due diligence? Contact Ron Rauch, or read more about due diligence and our Business Value Enhancement tool, CoreValue.
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