Due diligence for an SME could be a “Minefield” or a “Walk in the Park”. Which, is down to the preparation of your management team and the keeping of good and up-to-date records.
SMEs, will usually only experience being the subject of such detailed investigation into the affairs of their company when it is either seeking funding or the sale of its business. The level of such due diligence will also differ depending on whether it is one or the other.
What is due diligence?
Due diligence is the act of scrutinising all aspects of a target business ("Target") by a potential investor or buyer (“Dealer”) carried out to reduce risk and help them make a more informed decision in respect of that deal. Areas covered will not just be business records, but the Target’s market, management, prospects and competitive advantage. In certain circumstances, their Target should also check into the Dealers credentials to see what, in addition to cash, they could bring to the table, and if they will be compatible to the intentions of the business and their existing stakeholders
Any investigation prior to an exit by a potential buyer will normally be far more extensive than may be expected by an investor, and the quantum carried out by investors will vary relative to the type of investor and the sums being invested. Small subscriptions by a Business Angel may only attract a cursory review, whereas that carried out by a Fund Manager or Institutional Investor will be more thorough.
It's never too early
Whichever it may be, you can never start too soon preparing for such a review, and the earlier in the life of your business you commence collecting together copies of the relevant documentation the easier it will be. Having such information ready, available and easily accessible will not only impress the potential Dealer but make it easier for them to say yes, both to proceed with the deal and to the valuation. Some Dealers expect to find issues whilst carrying out DD, allowing them to seek a discount on a previously agreed value. Make it hard for them to do this.
Start from day one preparing files, either paper copies of the potentially required data or a scanned electronic version of the same papers. Making paper or scanned copies of current documentation as they arise is always much easier than hunting for such records many months later. Do however remember to update, replace or remove such documentation as they are renewed or overtaken by events. Too many times I have seen management put under pressure, and waste valuable time, trawling through filing cabinets, desk draws and their file explorer trying to pull together relevant contracts, leases, correspondence, or other required information before the due diligence team arrive to review it.
There's no hiding!
One final tip, management should consider is never hide skeletons in a cupboard from the due diligence team. Always be up-front about negative issues, highlighting what steps are being/can be taken to mitigate the problem. By doing so, it will be taken into consideration by the Dealer when agreeing on a price and thus cannot be used at later date to chip away at the valuation.
What areas could come under investigation?
In addition to accounting and statutory reports and records, reviewers will want to consider details on:
- management and your employees
- asset ownership
- legal contracts
- any litigation issues
- your market and competitive advantage.
Although this may seem comprehensive, it is not necessarily an exhaustive list of the potential areas that you could expect to be the subject of the deepest level of scrutiny. So think about what you would want to know about a competitor if you were going to acquire them and apply that logic to yourself, indeed sometimes interviews of key customers and/or suppliers may be requested.
Such a list may seem daunting, but if you create documents as they arise it will make your due diligence process much easier and quicker to prepare for.
Make it easy for them to say "yes"
Remember, Dealers look for an excuse to say 'no', so if they are “impressed” it is much easier for them to say “yes”. As your Finance Director, your FinanceHead can prepare your documents and support you and your management through the due diligence process. Contact Michael to find the right FinanceHead for your business.
FinanceHeads Director and Original Member