Making a Case for Capital

The private equity market is still running hot, and it’s a great time to sell all or part of your company to raise money to fund an expansion, purchase another business, or enjoy your retirement. But, of course, companies aren’t sold with a smile and a handshake. Before investors buy into a company, they typically use a discovery process called due diligence to investigate their potential purchase. They ask questions, review documents, and interview business principals to learn about the company they’re acquiring.

Due diligence can be expensive, time consuming, and inconvenient, but it’s a necessary part of any acquisition—and understanding the process can mean the difference between a smooth sale or a long wait.

In the Spotlight

The due diligence process begins early, when you first consider selling your company. There’s “no one-size-fits-all-approach” for due diligence, notes Peter Ekberg, co-chair of the emerging companies practice at Minneapolis-based law firm Faegre & Benson, LLP. “Different industries, different companies, and different reasons for selling makes for different questions each time.” Even so, there are some commonalities. An acquiring company will always want to see financial statements—reviewed or audited, if possible—for at least the last five years.

Due diligence is not glamorous, but it cannot and should not be completely farmed out to consultants—including lawyers—or even to lower-level employees.

Buyers will frequently request a wide variety of other information including notes from board of directors meetings; agreements with customers and vendors; budgets and budgetary projections; any marketing documents the company has used in connection with other sales or securities transactions, such as an initial public offering; employment agreements; employee benefit plans; information on any complaints, litigation, or threat of litigation; intellectual property files, including patents or patent applications, trademarks, and copyrighted material; and any claims of infringement made by or against the company.

“Typical buyers are going to want to know everything,” says Bill Cavanagh, a partner at Counsel Funding Partners, an Edina-based investment bank and management consulting firm. In highly regulated industries, buyers will also want to analyze evidence of regulatory compliance, investigations, or penalties.

As a seller, you’ll need to prepare all that information for potential buyers. What’s more, you may also want to get some of the same information from potential buyers, a practice known as reverse due diligence. Doing so is particularly vital if a deal will be financed through earn outs, in which a seller’s compensation depends on the money their business makes, post-sale, for the buyer. It’s also important when a seller will be paid, totally or in part, with equity in the buyer’s company. In that case, “you’re essentially making an investment in them as a company,” Ekberg says.

You might also be interested in how a suitor has handled past acquisitions. “Wouldn’t you like to know if they’ve sued the last three companies they’ve done transactions with?” Ekberg asks. Ask if you can speak with parties from other transactions and see examples of deal documents from other transactions. “Due diligence in any transaction should be mutual,” Ekberg says. “A seller probably won’t need as much due diligence as a buyer, but there needs to be some done.”