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Reverse due diligence enhances M&A value

03.29.15

If you’re preparing your business for sale, investing in reverse due diligence — also known as “sell-side” due diligence — can help you increase the likelihood of a successful transaction. It involves taking a hard look at the company through a prospective buyer’s eyes.

Many Benefits

Reverse due diligence provides many benefits, including:

Maximizing value. Reverse due diligence may help you achieve a higher sale price. By objectively analyzing the quality of your company’s earnings and the credibility of your forecasts, you can anticipate and address prospective buyers’ questions and concerns up front. This limits a prospective buyer’s ability to renegotiate the transaction’s price or terms later in the process.

Also, the process may reveal opportunities to enhance the business’s valuation. For example, it may help you identify adjustments that will have a positive impact on the company’s earnings before interest, taxes, depreciation and amortization (EBITDA), such as nonrecurring costs that are properly excluded from the earnings calculation.

Minimizing surprises. Buyers hate surprises, especially when they discover them during buy-side due diligence. Reverse due diligence helps you ensure that all potential concerns — including technology and human resources issues, operational deficiencies and tax risks — are disclosed in advance. This sort of transparency enhances your credibility and inspires confidence in prospective buyers.

Correcting problems. If you conduct reverse due diligence well in advance of offering your business for sale, you may have opportunities to correct problems before they have a negative impact on the sale price.

Suppose, for example, that you discover that your company is potentially liable for unpaid sales and use taxes in several states. Given the uncertainty over the extent of your exposure, a buyer may walk away from the deal or insist on a price reduction that reflects its risk. By coming forward voluntarily and negotiating with state tax authorities, however, you may be able to minimize your liability for taxes and penalties and provide prospective buyers with certainty regarding the extent of your liability.

Determining the most efficient tax structure. Reverse due diligence can help you structure a deal in the most tax-efficient manner for both buyer and seller. It may also identify valuable tax attributes (such as net operating losses) that support a higher sale price from buyers that can take advantage of them.

Easing concerns about carve-outs. A carve-out — in which a company sells a division, product line or other portion of its business — raises special challenges. Typically, these business units don’t maintain separate financial statements. And they may share management, employees, facilities, benefit plans, technology and intellectual property. As a result, it can be difficult — especially for a buyer — to develop an accurate picture of a division’s financial performance as a stand-alone entity.

Reverse due diligence enables you to provide buyers with the information they need to become comfortable with a carve-out transaction and to understand the target’s value.

Expediting the transaction. Reverse due diligence doesn’t eliminate the need for buy-side due diligence, but it can streamline the process. By compiling, organizing, analyzing and explaining due diligence information, you can avoid delays and shorten the time to close, particularly when you receive information requests from multiple prospective buyers.

Staying in control. If you merely react to buy-side due diligence, you’ll quickly find yourself on the defensive. On the other hand, conducting your own due diligence allows you to control the process and position issues in the most favorable light.

Get Help

It’s possible to conduct reverse due diligence on your own, but there are important advantages to using a CPA or other professional. An independent due diligence report by an objective third party lends credibility to the process and helps build trust with prospective buyers. Also, advisors with buy-side due diligence experience are likely to be less biased than your internal staff and better equipped to anticipate buyer concerns and spot potential red flags.

Finally, outsourcing the due diligence process minimizes the burden on your company’s management and staff, allowing them to focus on running the business and preserving or even building its value prior to sale.