Proper planning and advance preparation is essential for any M&A transaction. Whether you are contemplating selling your company in the near future or simply want to ensure your business is positioned for an eventual exit, conducting a comprehensive internal review, commonly referred to as a “Deal Audit,” should be at the top of your strategic agenda.
A Deal Audit is an internal due diligence investigation conducted by the seller with the goal of identifying critical legal, financial, and operational issues, potential problems, and deficiencies in advance of undertaking a transaction. Deal Audits are typically conducted by outside M&A counsel and/or a consulting firm, working in close conjunction with the company’s leadership and/or independent accounting firm.
In any M&A transaction, the counterparty – whether a lender, investor, joint venture partner, or acquirer – is certain to conduct extensive and thorough due diligence of the other party. Serious problems discovered during this due diligence investigation often lead to reductions in the purchase price or could even kill the deal in certain circumstances. A Deal Audit empowers business owners to identify and address potential issues early, avoiding awkward and expensive issues before third parties are involved.
Why Timing Matters
It is never too early to begin planning and preparing for an M&A transaction. Business owners who wait until they are seriously considering a sale often find that the “window of opportunity” is already beginning to close.
It is critical to undertake and complete a Deal Audit before negotiating a letter of intent with a prospective counterparty. Once LOI negotiations begin, the counterparty’s lawyers, accountants, investment bankers, and other advisors become involved and begin submitting comprehensive due diligence requests. All potential issues should be identified and appropriately addressed before these third parties enter the picture and begin diligence in earnest.
Deal Audit Overview
While Deal Audits should be tailored to the particular company and its industry, most comprehensive Deal Audits involve investigating three functional areas.
Legal: The legal review primarily concerns organizational documents, capitalization tables, securities issuances and compliance, corporate books and records, licenses and permits, material contracts, litigation history, and regulatory compliance across a broad spectrum of applicable laws.
Financial: The financial review includes a in-depth evaluation of historical financial statements and projections, accounting policies and procedures, GAAP compliance, tax filings, debt instruments, real estate and equipment leases, insurance policies, and lien searches.
Business/Operational: The business/operational review covers physical assets, employment matters and compliance with employment laws, management team capabilities, intellectual property portfolios, environmental compliance, customer and vendor concentration, and warranty claims.
The Benefits of Proactive Preparation
The ultimate goal of a Deal Audit is to maximize the probability of the transaction closing, the highest price possible, and with the most favorable terms and conditions to the selling party. Several important benefits flow from this proactive approach.
First, buyer confidence in the seller and its management team will simplify the process and help expedite the deal timetable. When buyers discover serious problems during due diligence, they often lose confidence leading them to dig deeper on diligence or walk away entirely. Conversely, a “clean” company telegraphs to the buyer that the business has been well-run and properly managed.
Second, one of the most critical risks for sellers is the risk of not closing once the process has begun. Failed deals can create a perception that the company is somehow “damaged goods,” causing customers, suppliers, and employees to become nervous while competitors become opportunistic. Additionally, a failed transaction can result in lower valuations for such company going forward.
Third, and of critical importance, a Deal Audit allows the seller to identify issues and resolve them when and in the manner the seller deems appropriate. When buyers discover problems, they invariably insist on the most expensive and comprehensive fix possible, whereas the seller, with advance notice, can often implement a simpler and less costly solution that adequately addresses the issue.
Conclusion
A comprehensive Deal Audit is an invaluable first step in any M&A Transaction. Identifying all issues and potential problems before negotiating an LOI and involving third parties will streamline the process, alleviate unnecessary stress, prevent deal fatigue, and ensure as smooth of a transaction as possible.
Mike Telford, Dentons
Michael Telford is a transactional lawyer and member of the Corporate and Mergers and Acquisitions practice groups. Throughout his career, Michael has successfully advised clients on a wide range of M&A transactions including mergers, acquisitions, divestitures, joint ventures, leveraged buyouts, debt and equity restructurings and minority equity investments. He has worked with public and private clients ranging from small startups to large multinational corporations.