Any lawyer who has been involved in corporate M&A for a period of time will be familiar with the process known as due diligence (DD). Most M&A lawyers will have been involved in conducting the legal DD for a prospective purchaser of either the shares or the assets of a target company. Purchasers and their M&A lawyers understand the importance and value of thorough DD.
In our experience, the value to vendors of DD conducted on themselves (vendor DD) before going to market is less well appreciated. DD by a vendor on itself before going into a sale process can contribute major value to a transaction from the perspective of both a vendor and a purchaser. On the other hand, lack of adequate vendor DD will very likely cause problems, sometimes very serious or fatal problems for a potential transaction.
We have been involved in numerous M&A transactions where a vendor has gone to market without first having conducted any or any adequate vendor DD. We have heard many reasons why vendors resist DD at an early stage including:
- it will take too much time, cost too much and divert management’s attention from running the business
- the purchasers will tell us what information they want
- let’s test the market before we devote the resources and see whether there is a likely purchaser
- we don’t want to ask a whole lot of questions or get people looking for documents and send out management questionnaires or we will tip off our people that something is going on
- we don’t want our intended sale to leak to the market
- if we give out information and no deal happens, our competitors will have our crown jewels
- we need to get to market now.
These are fair points. Effort, time and cost will be involved. Where confidentiality is important, there will need to be steps undertaken to preserve confidentiality. Sometimes the vendor’s advisors might say “we can sort out issues in the context of a purchaser’s DD”. In deciding whether and to what extent to conduct vendor DD, there is a cost versus benefit assessment to be made. Invariably, the weight for vendor DD will be on the benefit side.
A key element for a vendor in its DD is to identify issues with the company or the sale assets that may be seen as detrimental by potential purchasers and to address and rectify those issues before the sale process commences and certainly before those issues are pointed out by a potential purchaser. A purchaser pointing out problem issues not identified and addressed by the vendor is a primary reason for delays and additional costs and crucially, for reductions in the purchase price proposed by purchaser (in the vernacular, “chiseling”). Worse still, a vendor not being well prepared for the purchaser DD process may very well cause the purchaser to walk away from a potential deal.
For more on why vendor DD is so worthwhile and also why vendors should conduct DD on potential purchasers, see here.