This is the second in our series of Mergers and Acquisitions (M&A) articles written for us by Tim Stead of Squire Sanders (see his biog at the end of the article for contact details). The first is Sell Your Recruitment Business: The 5 Key Rules to Executing an M&A.
To the uninitiated or ill-prepared seller, due diligence is a daunting process. For many sellers, the notion that the books of the business will be opened up to prospective buyers to unearth skeletons or black holes in the business is an intimidating (if not terrifying) prospect.
As an owner or partner in a recruitment business, the keys to surviving due diligence (DD) and avoiding a price chip lie in: careful preparation, good timing and strategic thinking.
1. Finding time for the day job – why do you need to get DD right?
In order to best understand how to survive due diligence in the context of a sale of a recruitment business, lets first consider the potential negative consequences of getting due diligence wrong. A poorly-managed due diligence process can:
• increase the risk that staff, customers and other stakeholders become aware that the business is in a sale process. This can have disastrous consequences for morale and can increase pressure on the seller to close the deal, thereby shifting negotiating power from seller to buyer;
• have a hugely disruptive effect on the financial performance of the business. This risks giving a buyer the opportunity to re-open price negotiations;
• be an unnecessary and damaging source of friction between:
– seller (“Why is the buyer wasting time asking all of these irrelevant questions?”);
– buyer (“Why can’t the business answer these simple questions? It must be a mess!”);
– management (“We can’t sit around answering thousands of questions – we still have a business to run!”)
A poorly managed process can even cause the buyer to pull out. This can make it much harder for a seller to re-open negotiations with other buyers, leaving the seller high and dry.
In conducting DD, a buyer’s primary objective is to verify the valuation placed on the business and, if problems or gaps are identified, to protect that valuation by asking for a price reduction or changing the terms of the deal.
2. Avoid a Price Chip
A seller’s foremost priority in managing DD will be to avoid a price reduction. There are a number of strategies you can adopt to minimise this risk:
• If you have prepared well, by working with your advisers to collate the information early so as to present it cleanly and efficiently, then you should free up management time to focus on running the business and minimise operational disruption.
• Build procedural protections into Heads of Terms, e.g.:
– require the buyer to issue written price confirmation on a weekly basis, with the penalty that exclusivity terminates automatically if it is not forthcoming;
– include a timetable with milestones that the buyer must hit, again failing which the seller has the right to withdraw exclusivity.
• As soon as Heads are signed, inject urgency in the process – don’t assume that the deal is done once you have shaken hands on the price.
• Identify likely DD issues early and try to fix them. If they cannot be resolved, present them carefully so as to ensure that the buyer does not unfairly argue that they should go to price.
• Do disclose issues early in the process, but not before Stage 1 bids and valuations have been submitted – get a feel for buyers’ valuation first, so that the impact of an issue can be properly measured.
• Offer the buyer alternative protections to an upfront rice adjustment, for example indemnity cover (on terms that the seller retains conduct of the issue) with an escrow so the buyer has confidence he has recourse if a claim arises.
• Maintain competitive tension for as long as possible – defer exclusivity to as late in the process as you can.
3. Get DD right
For sellers, speed is key – it is the most vital element in successfully executing a deal. Once a buyer has signed heads, all aspects of the process must be focused on driving the deal towards completion. For that reason, buyers must be presented with a clean, well-organised business.
• Prepare thoroughly to make sure that due diligence runs smoothly. Well before the sale process begins, you should conduct an internal audit on all aspects of your business – ask your lawyers to prepare a short and tailored checklist of the key areas to focus on.
• The buyer’s advisers will concentrate on the financial and tax affairs of the business. If you don’t already have them in place, adopt solid financial controls and reporting procedures to produce good quality, reliable monthly management accounts and budgets. Ensure your tax affairs are in order and that your filings are well-maintained.
• From a legal perspective, focus on your contracts and compliance. So, ensure you have written, signed and dated contracts in place with customers, suppliers and employees. As far as employment is concerned, ask your lawyers to review the restrictive covenants of key employees for adequacy and enforceability. Ensure you are in compliance with relevant regulatory requirements, particularly in relation to employment and data protection laws.
• Settle litigation where possible or, if that is not possible, check to ensure that the business is covered by insurance.
• Consider instructing your advisers to prepare sell-side due diligence (or “Vendor Due Diligence”). This gives you control over how the business is presented and allows you to frame
ABOUT THE AUTHOR
Tim Stead is a Senior Associate in Squire Sanders’ London Corporate team. Tim advises on all types corporate transactions for clients in the recruitment sector, but the principal focus of his practice is M&A.
Tim has a wealth of experience in exit planning and managing the successful delivery of M&A transactions on time and to budget. He acts on behalf of both buyers and sellers, providing clear and pragmatic commercial advice to achieve clients’ objectives.
If you are considering any form of corporate transaction, Tim would be delighted to talk to you and will provide free and impartial advice, on a strictly confidential basis, without any obligation.
Tim can be contacted at: tim.stead@squiresanders.com or 0207 655 1413/ 07545 935 607. LinkedIn:http://uk.linkedin.com/in/timstead/
