The Most Effective Mechanism to Increase Valuations and Expedite the Sales Process is Anticipatory Sell-Side Diligence

When you are ready to sell your business, the two events you want to avoid are unexpected / unreasonable reductions in the valuation and delays to the transaction process. These are deal killers. Anticipatory sell-side due diligence is the process by which a seller takes a critical look at their operating results and assesses the valuation metrics, risks that their company may face before a sale, and the company’s readiness for the sale process. Sell-side diligence is a component of a thorough readiness strategy that will maximize value and reduce the probability of unexpected delays to the process. The most effective mechanism for the seller to maximize value and reduce the probability of unexpected delays is to:

• present a company that frames potential issues for the Buyer before they are unexpectedly identified later in the process;
• identify adjustments that increase the valuation; and
• present a company that is ready for diligence requests and questions. 

The transaction process begins with the seller providing financial and operational data to one or more prospective buyers in the hopes of receiving indications of interest. The financial data provided will include historical financial statements, financial projections, and internal data on performance by divisions, contracts, or products. The Buyers will utilize this data to determine a valuation.

The valuation is typically a market multiple times a valuation metric. The market multiple can vary by industry, the overall health of the market, the stage of the business, and other internal and external factors. The valuation metric is typically the Seller’s earnings over the last twelve months (“LTM”). The measure of earning most frequently use is EBITDA (earnings before interest, taxes, depreciation, and amortization). The Seller’s LTM EBITDA is also adjusted for non-recurring events or transactions that are not expected to continue post-close.

Once the transaction process is down to a smaller number of potential buyers, the buy-side financial due diligence will begin. This is the process of taking a closer look at the Seller’s financial performance over the past several years to determine if any adjustments need to be made to the valuation metric. Keep in mind that because the valuation metric is multiplied by the valuation multiple, any adjustment that is discovered during the diligence process can have an impact that well exceeds the adjustment amount. For example, if the Buyer’s valuation of $5,000,000 was based on $1,000,000 of LTM EBITDA and a multiple of 5.0x, and through diligence, the Buyer identifies an adjustment that reduces TTM EBITDA by $100,000, the Buyer might propose reducing the valuation of your business by $500,000 (i.e., $100,000 multiplied by the TTM EBITDA multiple of 5.0x).

Frame the issues for the buyers and provide our take of how they impact value – When you perform sell-side due diligence and identify potential issues or adjustments to the valuation in advance, you can frame the issues and get prepared. The company can gather in-depth information and present their interpretation of how the adjustment impacts the value. By presenting these issues upfront, potential buyers who look at these risks as gating issues or who disagree on the impact to the valuation will be able to make an assessment early in the process instead of later when they are one of few (if not the only) Buyers remaining in the process.

Present adjustments that increase the valuation metric – As you can imagine, the buyers are motivated to find adjustments that decrease the purchase price. The LTM EBITDA that is included in your marketing material is a starting point that many buyers feel they can reduce over the course of the transaction process. The sell-side diligence process is the opportunity for the Seller to identify and quantify adjustments to the valuation metric that positively impact the valuation. An example of a positive EBITDA adjustment could be a new customer, the elimination of an unexpected cost in the last year, or highly compensated executives that do not plan to remain with the company post-close. A thorough analysis of your financial results can result in material adjustments to the valuation.

Expedite the process – Minimizing buyer negotiations after the letter of intent often will result in a higher initial bid. And performing sell-side due diligence can sometimes make it easier to attract buyers because they often show more interest when this process is carried out. Since timing can affect price in a quick market, helping buyers reduce the time required for its own due diligence can result in a more generous offer. Timing efficiencies can also be achieved by having accurate historical and projected financial information and by addressing risks and fixing any major issues early in the process, ultimately reducing the back-and-forth inquiry process, which can sometimes take months. This is especially important for management teams that lack M&A experience, since they may not foresee all the elements that will be scrutinized closely by potential buyers. The quality and structure of a company’s accounting practices are one of the main focal points of sell-side due diligence, making it possible to catch potentially influential miscalculations. With the help of sell-side due diligence, critical issues can be identified early on and be resolved on time. Assessing your business’ financial position provides an opportunity for remediation of any uncovered issues, which can maximize the transaction value and speed up the sale process. Sellers will also have a much better chance of impressing buyers, increasing their sale price, and reducing the potential for a transaction.

Present a company that is prepared for diligence requests and has responses to diligence questions – Through sell-side due diligence, you can also anticipate questions, concerns, and requests the purchaser may have during the buy-side diligence process. The buyer may come forth with difficult questions, requests, or concerns that you may otherwise have not been expecting. By dealing with these issues in the first place during the sell-side due diligence process, you can prepare yourself to respond quickly and convincingly. Providing credible and accurate data, and being open about any potential problems that you have found, will prove to the purchaser that you can be trusted as a business partner and that your goal is to manage the sale smoothly and efficiently.

Whether it’s a narrow quality of earnings analysis or more comprehensive due diligence, Aprio can assist with your M&A process. In addition to sell-side due diligence, Aprio can assist Sellers by assisting in the preparation of documents, organizing documents in a data room, assisting in the negotiation process, and serving in an interim management capacity. Every deal is different, and whether it’s comprehensive sell-side due diligence support or assistance with a discrete task, Aprio can provide a solution that makes sense for your transaction.

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