Due diligence is the cornerstone of a business sale. It is the period of discovery when a buyer finds out what they are really buying. It is kicking the tyres, looking the horse in the mouth, turning over every stone. Pick whichever metaphor you like, but due diligence is something you must be ready for, and can so often be the undoing of a deal that looks otherwise sure. It’s a critical part of the dealmaking process.
Due diligence: fish and chips
Fish and chips is a phrase that has emerged in the M&A world to describe a buying strategy that has due diligence at its core. A potential buyer will make an offer that sounds too good to be true (spoiler: it is). This is the hook that catches the fish. The buyer then uses details from the due diligence process to chip (see?) away at the figure as the deal progresses. A big part of due diligence from a seller’s perspective is to be realistic and manage your own expectations for the sale.
That’s not to be encouraged as far as Gunner & Co. is concerned. But it’s something for vendors to be aware of as they head into the due diligence process. The danger of value being knocked down during due diligence is real. But it’s also avoidable. Start with finding a reputable broker who can help you to prepare. To mitigate against buyers finding areas of value they might deem negotiable, we have compiled a list of seven characteristics of highly successful due diligence.
The 7 characteristics of highly successful due diligence
Understanding due diligence is more than compiling a list of things a buyer might want to see. It is so important to understand what your approach to due diligence tells a buyer about how your business is run and, particularly in financial services, what sort of future liabilities they might encounter. Rather than make a list of details you might need to collate for due diligence, you can think of the following as the seven tenets of successful due diligence planning.
1. Be ready
Are you ready? Really ready? Many business owners looking to sell underestimate the number of questions and the level of detail demanded by a potential buyer. It’s important to anticipate as many of the questions you will be asked in advance and have answers to hand.
This process starts with deciding when you want to sell your business. Once you have an answer to that, you need to make the big decisions first – what’s your business worth? What are you worth? Are you going to stay on or leave the business post sale? What type of sale would you prefer? Then prepare for a number of scenarios that might differ to your ideal and start getting your house in order. That means being thorough (see number 3), being compliant (see number 4), being transparent (see number 5) and employing the right back office technology (see number 6).
Do you know about the ‘dirty taxi’ theory? If two taxis pull up to offer you a ride, do you take the clean one or the dirty one? The dirty one might be the better driver and have superior knowledge of the route, but your assumption based solely on the state of the vehicle is that the driver in the clean car is running a better business. It’s the same with due diligence – readiness speaks volumes to the buyer about what kind of business they are buying.
Being ready allows you to answer a buyer’s questions quickly, honestly and transparently. Consider starting a due diligence folder with contracts and files that are likely to be useful during the process. Your ability to look prepared when the many questions start rolling in tells the buyer a lot about how your business is run.
2. Honesty is the best policy
There is no such thing as the perfect business and you may think it’s better to downplay or hide the things you aren’t so proud of in your business practices or history. But if you are planning to sweep things under the carpet, be aware that the process of due diligence is, by its nature, lifting up that carpet AND the floorboards to look underneath. So be honest. If you get found out during due diligence it could sour the deal. Mistakes and omissions can happen honestly, but it is your duty to minimise these risks. Buyers do not like surprises – they can scupper or devalue a deal. Lack of honesty is much more likely to scupper a deal than poor DD findings. Most findings can be worked through, trust cannot be rebuilt.
Honesty is also a pillar of any healthy relationship – business or otherwise – so laying all your cards on the table is likely to create a stable base from which you can work through any stumbling blocks on the deal. Most of all, be honest with yourself.
3. It demands thoroughness
If the devil is in the detail, the buyer is going to want to make that pact. Be prepared to provide not just the basics – two years of new business register, FCA filings, compliance records – but quite granular detail on individual advisors, client segmentation and particularly any business outliers that may show up in your documentation.
A good back office function with sensibly organised filing is essential to react promptly to these kinds of request. Inability to respond to detailed questions during due diligence with thorough answers suggests to the buyer that your records or record keepers are in disarray. You should also be ready for further questions once you have provided your answers. If you don’t already have thorough, accessible answers in place, use the time between deciding to sell and going to market to rectify that. As we’ll come to later, using technology to keep your detailed records at arm’s reach is an excellent way to have answers at your fingertips – and will promote the idea that you have a forward-thinking business for sale.
Your financial results may attract a buyer but will they like the methods you’ve used to get them? Buyers like a boring business that runs on vanilla investments for a solid roster of long-term clients. They don’t want to see fly-by-the-seat-of-your-pants investments coming good for a rogue’s gallery of flighty pro-riskers. More than that, they want to be assured that everything – everything – is above board as far as the FCA, HMRC and the law is concerned. Have the proof that it is and be prepared to explain (honestly, see above) where there have been compliance breaches. You will need to be able to demonstrate this through documentation and should be able to defend any decisions you have made through your filings.
Any suggestion that the business has compliance lapses that can’t be adequately explained will jeopardise the deal, erode trust and lead to further probing. Nobody wants any of these things in the water.
5. Cultural transparency
We’ve talked already about ‘dirty taxi’ theory. It’s the little things that a buyer will comb through to try to distil the things about your business that can’t be quantified in a spreadsheet. It’s easy to think that a buyer will take your balance sheets at face value, but they will want to see that your cultural record is desirable too. One thing that will certainly interest the buyer is what your team looks like and what that tells them about the culture of your business in terms of employment records. If you’ve got a longstanding team around you, that puts you in good stead because it means they’re loyal, they like the way the business is run and they are relatively likely to stay put if asked to under new ownership.
But what if the staff attrition rate is high? That’s going to prompt questions in the buyer’s mind about why. Has the business got a culture of psychological safety? Are the team free to ask questions, challenge management decisions and offer improvements? Are the recruitment and induction processes thorough? They will want to dig up management and board meeting minutes. They may want to see staff development records. You should have these to hand anyway (see number 3) but the more questions a buyer is asking, the more likely they are looking for something that might be wrong.
6. Technology’s role
“Every company is a technology company.” That’s what Gartner’s global head of research said. In 2013. If – a decade later – yours is not, that tells a story about your business. It suggests old-fashioned ways, a reluctance to innovate or fear of the new. It also suggests your business may be more rooted in old-school hunch-based investment over newer, more reliable data-driven decision making. None of these things are likely to appeal to a buyer.
Technology is also a useful tool in the due diligence process itself, putting records and data sets at your fingertips where they can be accessed in seconds, not stuffed into a dusty filing cabinet which might slow down your response time (and cost of discovery). Slow delivery – to a buyer –suggests disorganisation.
Investing in back office technology helps you more easily provide answers to platform and client segmentation questions. It helps with accounting, operational costings and forecasting. It may also give your business an edge in the lead-up to the sale, increasing value ahead of going to market.
7. Data security
Data is critical to a buyer. Your data – well organised, well presented and available at the touch of a button – is what will ultimately interest a buyer. But they will also want to know that you are careful with your clients’ data. Does it comply with GDPR? Do you use third-party apps and are they compliant? Where is your data stored? Where do your software providers store their data?
Data is granular. That’s its strength. But if you can’t answer questions about where it’s held or who might be able to get hold of it, that will shake a buyer’s confidence in your company during due diligence.
Preparing for due diligence in a nutshell
As you can see, there’s a lot to think about ahead of due diligence and a lot to get ready. Knowing well in advance the sort of timeline you are thinking of for selling your business should equip you with time to prepare, improve and make your business more sellable (and more valuable).
The greatest preparation you can make for due diligence is not to underestimate how many questions you will be asked. You will probably still be surprised – but at least you are less likely to feel overwhelmed. Being ready to answer questions – and answer them with alacrity – is your secret weapon in the dealmaking process.
If you are honest, thorough and organised, you are prepared for due diligence.
Louise Jeffreys is managing director of Gunner & Co, an IFA broker with values based on strong relationships built on trust, credibility and value.
Gunner & Co. specialise in IFA sales, IFA business sales, retiring IFAs and IFA client bank sales.