Industry Articles

Do You Have an Exit Plan?

Whether you plan to sell your company immediately or in one year or five years, you need an exit strategy. As the term suggests, an exit strategy is a plan for leaving your business, and every business should have one, if not two. The first is useful as a guide to a smooth exit from your business. The second is for emergencies that could come about due to poor health or partnership problems. You may never plan to sell, but you never know!

The first step in creating an exit plan is to develop what is basically an exit policy and procedure manual. It may end up being only on a few sheets of paper, but it should outline your thoughts on how to exit the business when the time comes. There are some important questions to wrestle with in creating a basic plan and procedures.

The plan should start with outlining the circumstances under which a sale or merger might occur, other than the obvious financial difficulties or other economic pressures. The reason for selling or merging might then be the obvious one - retirement - or another non-emergency situation. Competition issues might be a reason - or perhaps there is a merger under consideration to grow the company. No matter what the circumstance, an exit plan or procedure is something that should be developed even if a reason is not immediately on the horizon.

First, any existing agreements with other partners or shareholders that could influence any exit plans should be reviewed. If there are partners or shareholders, there should be buy-sell agreements in place. If not, these should be prepared. Any subsequent acquisition of the company will most likely be for the entire business. Everyone involved in the decision to sell, legally or otherwise, should be involved in the exit procedures.

The next step to consider is which, if any, of the partners, shareholders or key managers will play an actual part in any exit strategy and who will handle what. A legal advisor can be called upon to answer any of the legal issues, and the company's financial officer or outside accounting firm can develop and resolve any financial issues. Obviously, no one can predict the future, but basic legal and accounting "what-ifs" can be anticipated and answered in advance.

A similar issue to consider is who will be responsible for representing the company in negotiations. It is generally best if one key manager or owner represents the company in the sale process and is accountable for the execution of the procedures in place in the exit plan. This might also be a good time to talk to an M&A intermediary firm for advice about the exit process itself. Your M&A advisor can provide samples of the documents that will most likely be executed as part of the sale processes; e.g., confidentiality agreements, term sheets, letters of intent, typical closing documents. The M&A advisor can also answer questions relating to fees and charges.

One of the most important tasks is determining how to value the company. Certainly, an appraisal done today will not reflect the value of the company in the future. However, a plan of how the company will be valued for sale purposes should be outlined. For example, tax implications can be considered: who should do the valuation, are any synergistic benefits outlined that might impact the value, how would a potential buyer look at the value of the company?

An integral part of the plan is to address the due diligence issues that will be a critical part of any sale. The time to address the due diligence process and possible contentious issues is before a sale plan is formalized. The best way to address the potential "skeletons in the closet" is to shake them at this point and resolve the problems. What are the key problems or issues that could cause concern to a potential acquirer? Are agreements with large customers and suppliers in writing? Are there contracts with key employees? Are the leases, if any, on equipment and real estate current and long enough to meet an acquirer's requirements?

The time to address selling the company is now. Creating the basic procedures that will be followed makes good business sense and, although they may not be put into action for a long time, they should be in place and updated periodically.

How Does Your Business Stack Up?

Determining the value of your company rests on a few basic value drivers. It can be difficult to place a specific value on a given company; however, a seasoned professional such as an M&A Advisor can achieve a fairly accurate ballpark figure for what your business is worth.

Ultimately, the possible value drivers are practically endless. That stated, take a moment to carefully evaluate the ones listed to the right as they will give you some idea as to where your business currently stands. Remember that you shouldn't just compare your business against businesses in general, instead you should compare your business against specific competition. Finally, consider what you can do, as part of your overall exit strategy, to improve your company.

Value Chart

A recent Price Waterhouse Coopers survey of 300+ privately held businesses in the United Stated outlined the most common steps companies take to improve their prospects for a successful sale. These 7 steps should be undertaken before placing a business for sale:

  • Restructure debt
  • Improve profitability by cutting costs
  • Fully fund the company pension plan
  • Improve the management team
  • Upgrade computer systems/processes
  • Seek the advice of a consultant, intermediary or M&A Advisor
Sellers Need to Realize What Serious Buyers Want

Serious buyers will always want to look at your financials, but there are other key areas that they are sure to want to examine. Here are the six key areas where buyers will look when evaluating a business.

  • The Industry: Buyers typically examine the industry as a whole including customers, suppliers, the competition and the future outlook of the industry when they are considering buying a business. That means they'll want to uncover the strengths and weaknesses of your business as well as potential threats from competition and opportunities for growth.
  • Cash Flow: You can expect serious buyers to take a very hard look at your cash flow statements. The simple fact is that buyers will want to be quite certain that the business will continue to generate positive cash flow after the acquisition.
  • Wages and Salaries: Cost saving devices, of course, make the bottom line look good, but a high level of employee turnover can be a real concern as it creates expenses down the road. Keep in mind that if the target company is to be absorbed by another, then compensation issues could play an enormous role.
  • Discretionary Costs: Discretionary costs such as research and development, advertising and public relations will likely receive attention for buyers as well. Many sellers will attempt to reduce these costs in an attempt to create a higher bottom line; however, such cuts will serve to hurt the future bottom line.
  • Capital Expenditures: A serious buyer will also factor in machinery and equipment to ensure that they are up-to-date and equal to or even superior to that of the competition. Replacing outdated equipment may help boost the offering price.
  • Obsolete Inventory: No doubt, obsolete inventory can negatively impact the purchase price. If possible, address obsolete inventory before selling.

Over and Above the Numbers

Whenever a merger or acquisition is in order, a close review of financial statements is a must. Yet, there are other assets to consider. Let's review ten of the most important, and sometimes overlooked assets:

  • Repeat customers or clients
  • Broad customer or client base that is diverse and growing
  • Long-term contracts
  • Profitable alliances
  • Recognizable brand name or product name
  • Patented products, government approval & profitable copyrights
  • Proprietary products
  • Valuable intellectual property
  • Experienced management team & trained workforce
  • Contracts/non-competes with valuable employees

The Letter of Intent

After a buyer has made an offer, the next step is for that buyer to present a Letter of Intent. In the Letter of Intent, the buyer outlines the terms of the possible transaction. The seller should also provide his or her thoughts as to what should be covered. Here are six key points that should be addressed in any Letter of Intent:

  • Price and terms
  • he assets & liabilities to be included
  • Employee contracts & severances
  • Lease or sale of property
  • Assumption of contracts & warranties
  • Time schedules of due diligence and closing
How Does One Determine if Now is the Right Time to Sell?

Answering the question, "Is now the time to sell?" can be a tricky one, as it depends on a wide variety of complex factors. Many studies are pointing to the fact that as baby-boomers retire there will be a dramatic spike in the number of businesses for sale.

In general, the view is that as the baby-boomers retire, they will be selling their businesses. In one study, an eye-opening 57% of business owners noted that age was indeed a factor in their decision to sell and move on. Additionally, another study found that 75% of owners with revenues between $1 million and $150 million wanted to sell their business in just the next three years. Added together, it becomes clear that there will likely be a lot of businesses for sale in the near future.

There are both good reasons to sell now as well as some reasons to consider holding off. Let's first take a look at some of the most important variables and begin by looking at the key reasons to sell now.

Why Sell Now?

The issue of capital gains tax rate is one to discuss with your accountant, as this rate may impact whether now is the right time to sell. A second reason to consider selling now is very straightforward: you're burnt out.

Burn-out is very real and if you are burnt-out, then selling may be a good idea for many reasons. If you've simply had enough, your business will suffer as a result, as you will end up putting less creative energy and effort into the business. Maybe you're losing customers or are paying a supplier too much and you simply don't care or feel like investing the time to remedy the situation. This is a bad sign. The ultimate result of these decisions may be a decrease in the value of your business as you lose market share, customers and momentum.

When you've "had enough" selling is usually a good idea.

Reasons to Wait

Currently, the economy is growing, and that is yet another reason to consider selling. But there are also reasons you might want to wait. Let's consider the flipside of the issue.

But what if your business had a down year but you know that next year will definitely be better and prosperous? Let's say you've landed a new large client or an existing client is boosting spending. In these scenarios, waiting a year to sell is likely an excellent idea.

In such a situation, you will likely achieve a much better final sales price for your business. However, waiting a year does come with some risks even if you have a new client or new contract.

For example, what happens if a new competitor enters the market or there is a major economic downturn? We can never fully hope to predict future movements in the market or market trends, and that means there is always risks associated with waiting to sell.

Another factor to consider is whether or not there could be a tightening of credit. Most buyers will need to finance a significant portion of the purchase of your business. If lending requirements tighten, selling your business could be much more difficult as a result. Even if your businesses financials improve dramatically while you are waiting to sell; if credit tightens, then it could end up being more difficult to sell.

Remember that the time to plan your exit strategy is when you start your business. The simple and undeniable fact is that business owners, no matter how savvy, simply can't outgrow factors such as aging, interest rates or capital gains.

In the end, the time to sell is when you are ready to sell. That stated, tax implications should be weighing heavily on your decision to sell during the next two to three years. Working with an M&A Advisor can help you gain clarity as to whether or not now is the right time to sell!

Preparing a Business for Sale

For sellers to receive top dollar for their businesses, planning is critical! It is not something to put off just prior to the decision to sell. Following are some factors to consider, both long-term and short-term.

Long-Term Considerations

deally, the seller will start planning a full year or more in advance of a sale, because numerous elements will take considerable time and expense to execute. Many small private companies, for example, have their financial documents "reviewed" or "compiled" but rarely audited. Auditing statements involves conducting an actual physical inventory, with each accounts receivable and all other financial details verified in the process. While audited statements are mandatory for public companies, many private companies opt not to pay the extra cost of auditing, which can range from $10,000 to $40,000. However, an audited statement, which is a verification of the reported numbers in the financials, may result in a higher offer by the buyer.

Other items to address in preparation for selling a company include cleaning up the balance sheet of old debts and writing off uncollectable accounts receivable and old inventory. This ensures that the buyer is not deterred by a less than pristine financial statement.

Settle outstanding lawsuits and engage top management in non-competitive and stay agreements.

Further, make sure the plant is in excellent physical shape; spruce it up if need be. If the facility does not show well, it will very quickly turn off buyers.

Short-Term Considerations

In addition to the long-term issues discussed above, certain elements need to be considered in the short term. Prior to going to market with the sale of a company, sellers need to allocate about two to four months for organization purposes. A critical element in organizing a business sale is to assemble a team of advisors, including a mergers and acquisition (M&A) intermediary. This representative will partner with the seller during the entire selling process and will probably be in contact with the seller almost daily for the next six to twelve months. The intermediary will also orchestrate the process and act as "quarterback" for the team of advisors. A transaction attorney, an accountant, and most likely a tax attorney who will be knowledgeable about the company's personal affairs should also be by the seller's side.

Next, it is advisable to have a valuation of the business that not only determines the "anchor" price but also supports the seller's reasoning in the negotiating process. Along with the business appraisal, sellers should consider obtaining a machinery/equipment appraisal and a real estate appraisal. The buyer will need these separate appraisals to know what will be required in order to finance some of the hard assets.

Finally, the preparation of the selling memorandum by the intermediary is the major selling tool in the entire process. This document describes in detail the industry, the company, the financials, and investment considerations.

Along with this document, a seller should have a "war room" of various documents pertaining to the business: lease agreements, bank agreements, a sales representative agreement, and corporate minutes. The war room would be the single place where all of the necessary secured files are kept. These files contain all the pertinent facts of the company, which buyers will want to review as part of their due diligence process.

There is an old saying that the right time to prepare to sell your company is the day you start or purchase it.

Confidential Business Memorandum

Confidential Business Memorandum includes all those points one would normally expect to see in any business plan, to wit: an executive summary, a business description, financial requirements, target market niche, identification of top management, an operations review, analysis of strengths and weaknesses, and past/current/projected financial statements.

Guide to Mergers and Acquisitions

A proposed sale of a middle-market company almost always begins with a Confidential Business Memorandum. This document is called many things including offering memorandum, confidential descriptive memorandum or simply the book. Regardless of what you chose to call it, its purpose is to encourage prospective buyers to take a further look at the company.

For the seller, it has a secondary side benefit. It forces them to take a hard look at their company, its strengths and its weaknesses. Upon reviewing the information necessary to prepare a Confidential Business Memorandum, the seller may, in fact, decide that it's not such a bad company after all and elect not to sell it. On the other hand, the seller could decide that the current condition of the company needs to be improved before attempting to sell it. Looking at the company through the eyes of a buyer, as it were, could also prompt the seller to try to increase the value prior to selling. This may be done, for example, by building stronger brand loyalty or entering into employee contracts with key managers or perhaps by diversifying the customer base.

Assuming, however, that the decision to sell has been made, the importance of the Confidential Business Memorandum cannot be emphasized enough. It is like a strong advertisement for the company and must tell a good story. It should highlight the positive parts of the company, add value for the buyer, and show the negatives as opportunities. The Confidential Business Memorandum must make a good first impression. A seller wants to attract qualified buyers and bring value to the company being sold. This means that the Confidential Business Memorandum should be prepared and written by a professional. It is too important a document to do otherwise. It is also the basis of a strong marketing program to attract the best buyer at the best price.

What makes up a strong Confidential Business Memorandum? It includes quite a few different elements. But, first a few caveats:

  • Don't include highly confidential company information or reveal trade secrets. Although the document may be intended for qualified buyers only, once it is disseminated it really becomes a public document. Professional intermediaries and investment bankers do make prospective buyers sign a confidentiality agreement, which does help in this area. Still, with copy machines and email services readily available, it never hurts to retain highly confidential information until the discussions have matured to serious negotiations.
  • Make sure that a prospective buyer knows exactly what assets are being included in the transaction. It is assumed unless otherwise mentioned that it is the entire company that is for sale. You don't want prospects to think that they can purchase just the most profitable portions of the company. Obviously, a seller wants to show-off the excellent parts of the company, but this should not be done at the expense of the not-so-good parts. Shortcomings can be presented as excellent opportunities.
  • The Confidential Business Memorandum should not be aimed at the right prospects. If the business requires technical language to best explain it, use it. A buyer, who doesn't understand it, probably isn't a buyer.
  • There should be an explanation of how the company works so a prospective acquirer can read through the lines about the selling company's corporate culture. This element can make or break a sale and it's best to discover it at the outset.
  • There is always a tendency to include too much information - don't. Don't over-sell. You don't need to include the names of customers and vendors and the names of all the employees.
  • Be sure to also include the blemishes. If there is a pending lawsuit, include. The bad news should be revealed early on - no one likes surprises, especially later in the negotiations.
  • And, finally, and probably, most important, the Confidential Business Memorandum should be easy to read.

Now, what about the various elements of the Marketing Teaser and the Confidential Business Memorandum.

Marketing Teaser (Teaser) – The Teaser may be the most important element of the selling process and precedes the delivery of the Confidential Business Memorandum. The Teaser profiles the entire offering and highlights should be covered in brief - no more than one or two -pages - at most. Remember the sole purpose of the business Teaser is to generate excitement and interest. It is a selling piece! It should include:

  • Ownership Structure
  • Brief Business Description
  • Financial Highlights
  • Products and/or Services
  • Targeted Markets
  • Opportunities for Improvement
  • Reason for Sale (Why is it for sale?)

This Teaser is sent to possible purchasers. If the prospect is interested further, they sign a confidentiality agreement before receiving the Confidential Business Memorandum. The Confidential Business Memorandum includes detailed information on the key elements of the company and usually covers the following:

  • Business overview - In other words, who and what is the company? This is the place where everything about the company is summarized: its history, the employees (in general), the management team, the locations, any important intangible assets, and the outlook for the business.
  • Company strengths - What does the company do well? This should cover those strengths that bring value to this company.
  • Markets - Who are the customers/clients? What and how does the company sell its products or market its services.
  • The Risks - What are they? If there are risks in the business, they should be described and then an explanation of how the company solves them.
  • Financial data - Is the company making money? Cash flow statements are important. Current thinking is that the seller doesn't have to include all the available financial data - which the prospective buyer will go through all the financial history as the deal moves forward.

  • The Confidential Business Memorandum should include any relevant corporate and/or product brochures, as attachments. Prior to putting the business on the market, it is important that market pricing expectations be discussed with the seller. However, the price and terms are not usually a part of the Confidential Business Memorandum - the marketplace will dictate the price and associated transaction terms. The purpose of the Confidential Business Memorandum is to generate enough interest that a prospective acquirer will make an offer.

    Building Value

    Prior to putting a company on the market for sale, the question of value must be addressed. Increasing the value should, in fact, be considered a year, preferably two, prior to sale. Value is based on profitability, cash flow, management and the overall quality of the operation itself. Here are some considerations in building value, whether the business is going to be sold or not.

    • Are the company's pricing policies set too low creating low margins? Perhaps they were set some time ago in order to boost sales. Now might be a good time to review them to make sure they are in keeping with current market conditions.
    • Is the inventory level too high? How about work-in-progress or finished goods? Increasing the turns in inventory can increase cash flow.
    • Are you paying too much for raw material? Talk to your vendors and suppliers, you might be able to get some better prices or terms. Look at all the expenses: utilities telephone, technology, office expense - it all adds up.
    • Are there services that could be outsourced for increased savings?
    • Increasing the quality of customer service may entice customers or clients to pay their bill promptly.
    • Are all the employees working together to improve the operation and profitability of the company?

    • These are just a few of the areas that can and should be reviewed. Although profits are important, there is an old expression that cash is king. The time to look at the overall company operations is now.

      Measuring the Value of a Company

      Consider the following important areas of a company. How does your company stack up in these critical areas? If you were to rank them on a 1 to 4 scale, for instance, what would your score be? The higher the score the more valuable the company! They are considered value drivers - in other words, they are important to a prospective buyer.

      • Profitability
      • Type of business
      • History of the company and industry
      • Business growth
      • Customers/Clients
      • Market share
      • Return on investment
      • Quality of financial statements
      • Size
    • Management
    • Terms of sale

    For example, in looking at a company's financial data - are the statements audited or merely compiled? Is the growth of the company slow or is it growing quickly? How about the customer base - is it based on several major ones, or is it spread out over many customers? The time to consider these critical value drivers is now!

    What Makes Your Company Unique?

    There are unique attributes of a company that make it more attractive to a possible acquirer and/or more valuable. Certainly, the financial performance is important, but potential buyers will also look beyond them. Factors that make your company special or unique can often not only make the difference in a possible sale or merger, but also can dramatically increase value. Review the following to see if any of them apply to your company and if they are transferable to new ownership.

    Brand Name or Identity

    Do any of your products have a well recognizable name? It doesn't have to be Kleenex or Coke, but a name that might be well known in a specific geographic region, or a name that is identified with a specific product. A product with a unique appearance, taste, or image is also a big plus. For example, Cape Cod Potato Chips have a unique regional identity, and a distinctive taste. Both factors are big pluses when it comes time to sell.

    Dominant Market Position

    A company doesn't have to be a Fortune 500 firm to have a dominant position in the marketplace. Being the major player in a niche market is a dominant position. Possible purchasers, acquirers, such as buy-out groups, look to the major players in a particular industry regardless of how small it is.

    Customer Lists

    Newsletters and other publications have, over the years, built mailing lists and subscriber lists that create a unique loyalty base. Just as many personal services have created this base, several other factors have contributed to the building of it. The resulting loyalty may allow the company to charge a higher price for its product or service.

    Intangible Assets

    A long and favorable real estate lease (assuming it can be transferred to a new owner) can be a big plus for a business. A recognizable franchise name can also be a big plus. Other examples of intangible assets that can create value are: customer lists, proprietary software, an effective advertising program, etc.

    Price Advantage

    The ability to charge less for similar products is a unique factor. For example, Wal-Mart has built an empire on the ability to provide products at a very low price. Some companies do this by building alliances with designers or manufacturers. In some cases, these alliances develop into partnerships so that a lower price can be offered. Most companies are not in Wal-Mart's category, but the same type relationships can be built to create low costs and subsequent price advantages.

    Difficulty of Replication

    A company that produces a product or service that cannot be easily replicated has an advantage over other firms. We all know that CPA and law firms have unique licensing attributes that prevent just anyone off the street from creating competition. Some firms have government licensing or agreements that are granted on a very limited basis. Others provide tie-ins that limit others from competing.

    Proprietary Technology

    Technology, trade secrets, specialized applications, confidentiality agreements protecting proprietary information - all of these can add up to adding value to a company. These factors may not be copyrighted or patented, but if a chain of confidentiality is built - then these items can be unique to the company.

    There are certainly other unique factors that give a company a special appeal to a prospective purchaser and, at the same time, increase value. Many business owners should look beyond the financials and take an objective look at the factors that make their company unique.

    Top Ten Mistakes Made by Sellers

    • Neglecting the day-to-day running of their business since it will sell tomorrow.
    • Starting off with too high a price since the price can always be reduced.
    • Assuming that confidentiality is a given.
    • Failing to plan ahead to sell/deciding to sell impulsively.
    • Expecting that the buyers will only want to see last year's P&L.
    • Negotiating with only one buyer at a time and letting any other potential buyers wait their turn.
    • Having to reduce the price because the sellers want to retire and are not willing to stay with the acquirer for any length of time.
    • Not accepting that the structure of the deal is as important as the price.
    • Trying to win every point of contention.
    • Dragging out the deal and not accepting that time is of the essence.
    What Are Buyers Looking for in a Company?

    It has often been said that valuing companies is an art, not a science. When a buyer considers the purchase of a company, three main things are almost always considered when arriving at an offering price.

    Quality of the Earnings

    Some accountants and intermediaries are very aggressive when adding back, for example, what might be considered one-time or non-recurring expenses. A non-recurring expense could be: meeting some new governmental guidelines, paying for a major lawsuit, or even adding a new roof on the factory. An argument could be made that some non-recurring expenses are a one-time drain on the "real" earnings of the company. Be thoughtful about what one time non-recurring expenses are add-backs. If these add-backs are not real, they can inflate the earnings, resulting in a failure to reflect the real earning power of the business.

    Sustainability of Earnings

    The new owner is concerned that the business will sustain the earnings after the acquisition. In other words, the acquirer doesn't want to buy the business if it is at the height of its earning power; or if the last few years of earnings have reflected a one-time contract, etc. Will the business continue to grow at the same rate it has in the past?

    Verification of Information

    Is the information provided by the selling company accurate, timely, and is all of it being made available? A buyer wants to make sure that there are no skeletons in the closet. How about potential litigation, environmental issues, product returns or uncollectible receivables?

    The above areas, if handled professionally and communicated accurately, can greatly assist in creating a favorable impression. In addition, they may also lead to a higher price and a quicker closing.

    A Buyer's Questionnaire

    Prior to the more formal buyer's due diligence process, a questionnaire will most likely be submitted requesting responses from the seller. Following are some of the questions that might be asked of the seller. Note that a "yes" response will require an explanation from the seller. There may also be a need for disclosures regarding regulations and/or legal issues as requested by the purchaser.

    • Is the business in default of any of its financial or contractual obligations?
    • Are there any revenues or expenses that are not clearly reflected in the financial statements?
    • Has the business or any of its owners been the subject of any bankruptcy filing, assignment for benefit of creditors, or insolvency proceedings of any kind during the past five years or has the business or any of its owners consulted with any attorney or advisor concerning such proceedings?
    • Are there any individual customers or clients who account for more than 10 percent of annual gross sales? If yes, list each by name and indicate the approximate percentage of annual gross sales and the relationship of the client to the business or its owners, if any.
    • Are there any commitments to employees or independent contractors regarding future compensation increases?
    • Are there suppliers who have a personal or special relationship with the business or any of the owners? If yes, list each such supplier, the nature of the relationship, and the approximate amount of annual purchases.
    • Are any of the employees or independent contractors related to any of the owners of the business, or to one another? If yes, list them by name and describe their relationship.
    • If any of the business's premises are leased, are there any disputes between the parties and is either party out of full compliance with the terms of the lease or leases?
    • Have there been any deaths, violent crimes or other criminal activity on the premises within the past three years?
    • Are there any substances, materials, or products on or near the premises which may be an environmental hazard such as, but not limited to, asbestos, formaldehyde, radon, paint solvents, fuel, medical waste, surface or underground storage tanks or contaminated soil or water?
    • Is there any equipment used in the business that it does not own, is not in good operable condition, or on which maintenance has been deferred?
    • Does the business have a franchise, distributorship or licensing agreement? If yes, provide a copy of each.

    As intimidating as a due diligence questionnaire can be, honest disclosure is critical to avoid legal repercussions later on.

    The Deal Is Almost Done - Or Is It?

    The Letter of Intent has been signed by both buyer and seller and everything seems to be moving along just fine. It would seem that the deal is almost done. However, the due diligence process must now be completed. Due diligence is the process in which the buyer really decides to go forward with the deal, or, depending on what is discovered, to renegotiate the price - or even to withdraw from the deal. So, the deal may seem to be almost done, but it really isn't - yet!

    It is important that both sides to the transaction understand just what is going to take place in the due diligence process. The importance of the due diligence process cannot be underestimated. Stanley Foster Reed in his book, The Art of M&A, wrote, "The basic function of due diligence is to assess the benefits and liabilities of a proposed acquisition by inquiring into all relevant aspects of the past, present, and predictable future of the business to be purchased."

    Prior to beginning the due diligence process, buyers should assemble their expert advisors to assist in this phase. These advisors might include appraisers, accountants, lawyers, environmental experts, marketing personnel, etc. Many buyers fail to add an operational person familiar with the type of business under consideration. The legal and accounting side may be fine, but a good fix on the operations themselves is very important as a part of the due diligence process. After all, this is what the buyer is really buying.

    Since the due diligence phase involves both buyer and seller, here is a brief checklist of some of the main items for both parties to consider.

    Industry Structure

    Figure the percentage of sales by product line, review pricing policies, consider discount structure and product warranties; and if possible, check against industry guidelines.

    Human Resources

    Review names, positions and responsibilities of the key management staff. Also, check the relationships, if appropriate, with labor, employee turnover, and incentive and bonus arrangements.


    Get a list of the major customers and arrive at a sales breakdown by region, and country, if exporting. Compare the company's market share to the competition, if possible.


    Review the current financial statements and compare to the budget. Check the incoming sales, analyze the backlog and the prospects for future sales.

    Balance Sheet

    Three areas should especially be reviewed. Accounts receivables should be checked for aging, who's paying and who isn't, bad debt and the reserves. Inventory should be checked for work-in-process, finished goods along with turnover, non-usable inventory and the policy for returns and/or write-offs.

    Environmental Issues

    A required and quite complicated process. Ground contamination, ground water, lead paint and asbestos issues are all reasons for deals not to close, or at best not to close on a timely basis.


    This is where an operational expert can be invaluable. Does the facility work efficiently? How old and serviceable is the machinery and equipment? Is the technology still current? What is it worth? Other areas such as the manufacturing time by product, outsourcing in place, key suppliers - all of these should be checked.

    Trademarks, Patents & Copyrights

    Are these intangible assets transferable and whose name are they in. If in an individual name - can they be transferred to the buyer? In today's business world where intangible assets may be the backbone of the company, the deal is generally based on the satisfactory transfer of these assets.

    Due diligence can determine whether the buyer proceeds with the deal or begins a new round of negotiations. By completing the due diligence process, the buyer process insures, as far as possible, that he or she is getting what they bargained for. The executed Letter of Intent is, in many ways, just the beginning.

    Buying a Business - Some Key Considerations

    • What's for sale? What's not for sale? Is real estate included? Is some of the machinery and/or equipment leased?
    • Is there anything proprietary such as patents, copyrights or trademarks?
    • Are there any barriers of entry? Is it capital, labor, intellectual property, personal relationships, location - or what?
    • What is the company's competitive advantage - special niche, great marketing, state-of-the-art manufacturing capability, well-known brands, etc.?
    • Are there any assets not generating income, and can they be sold?
    • Are agreements in place with key employees and if not - why?
    • How can the business grow - or, maybe it can't!
    • Is the business dependent on the owner? Is there any depth to the management team?
    • How is the financial reporting handled? Is it enough for the business? How does management utilize it?