Acquisition rush risks due diligence failures
8th December 2020
Regular readers will have seen some of my thoughts about due diligence before, but I write this against the backdrop of significant deal activity in the sector.
There is a rush, in some cases, to complete transactions prior to the next Budget, now scheduled for 11 March 2021, when there may be changes to the capital gains tax regime which could have a negative impact on what vendors receive.
I am witnessing a wide range of approaches to due diligence, so here is my take on what is – and is not – good practice.
Timely, proportionate and sequential
Most transactions involving the sale of advice firms are completed on share purchase basis. As the acquirer is buying the company or partnership, and not the assets, they need to undertake due diligence to protect themselves in relation to the potential liabilities in the business – not just the advice provided but also the financial information on which their offer is predicated, as well as the liabilities inherent in advisers’ employment contracts.
That said, practice varies among buyers as to what information is requested and when.
Some ask for relatively little information prior to making an indicative offer/issuing heads of terms beyond financial information, while others go much further and want to analyse the client base or perhaps the defined benefit transfer business transacted.
The argument of buyers who ask for more information at the outset is that it enables them to make a more accurate offer that fully values the business and leaves less likelihood issues will be identified later.
The view taken by those who ask for relatively little information initially is that they want to agree the value of the business and the deal shape before doing a lot more work.
There is no right or wrong approach but I would suggest the seller will want to have qualified the would-be buyer before spending a lot of time supplying information.
Particularly annoying for a seller is where a buyer keeps coming back for more information in a haphazard way, or where agreed deadlines to make offers are not adhered to when all previously requested information has been provided. The converse also applies where sellers do not meet agreed deadlines. In both instances, it can erode confidence and even the outcome of the transaction.
The sequence in which due diligence is undertaken is also important. Dealing with areas that could be sensitive and have a bearing on the deal first is most logical – an obvious example in the current market being DB transfers.
Most of the focus of due diligence is on what the uyer wants from the sellers, leaving what the seller wants often taking a back seat.
But it is equally important for the seller to have a focused list of questions and requests to put to the buyer. The more obvious ones to put to “serial” buyers backed by private equity include “what is your source of funding, and may we see evidence?” and “can I talk to principals of other firms that have been acquired, both recently and some time ago?”.
Answer the questions
I am often asked how to answer the due diligence questions and my response is to treat the process like an exam. In other words, answer the questions that have been asked, not ones you would find easier to do so.
Other tips include only supplying additional information where it is relevant and ask questions yourself if you are not sure what exactly is being sought. Meanwhile, double check the responses before they are sent (or even better, ask someone else to) and note it is customary to supply the information via a data room, so there is a clear and complete record that you can vouch for in the sale and purchase agreement.
Buyers can pass on the comments from those undertaking the due diligence ad verbatim and, in the case of this being done by external contractors, these can sometimes appear harsh. A little forethought goes a long way to prevent offence being taken.
Due diligence is a necessary evil in any transaction involving the sale/acquisition of advice firms. It must be seen as an enabler, not an obstacle, to the completion of a transaction. Done well, it can enhance the standing of the acquirer and the perception of the seller, but both parties need to understand the other’s position and perspective.
This article was originally published on Money Marketing