Beating Your Buyer to the Punch Can Maximize Value– April 05, 2016 by Justin Thomas

With a heightened level of M&A activity and a significant amount of cash looking for high-quality investments, many private businesses are increasingly considering selling all or part of their companies or non-core product lines. Whether it’s to diversify net worth, create liquidity or recapitalize for growth, being prepared for the sale process can pay dividends.

What Is There to Prepare For?
In almost every transaction, a potential buyer will perform due diligence on a target company to confirm initial indications of value. Generally, the most time-consuming part is the accounting, financial and tax due diligence process, in which the buyer and his advisors take a deep dive into the seller’s historical financial records and forecast. The team performs a number of analyses on the seller’s historical income statement and balance sheet to verify the quality of the historical earnings (Q of E analysis), ensure financial projections are in line with normalized historical performance, confirm appropriateness of balance sheet positions, identify any potential unrecorded and undisclosed liabilities, identify tax opportunities and risks, and understand the working capital requirements of the business. Due diligence findings in any of these areas may change the buyer’s perception of value and the ultimate purchase price (almost always a downward move).

Much of the time in this process is backward-looking, to help the buyer substantiate the forecasts on which he is valuing the business. While most companies have a solid handle on their financial statements, they rarely analyze a trailing three-or-five-year period of financial performance, revenue and margin trends by customer, product, etc., to the extent the buyer will. And while many companies have a definition of adjusted EBITDA based on debt agreements; the buyer and his advisors will be looking for other adjustments to reported historical earnings, focusing on negative items.

A sophisticated buyer will use the due diligence process to identify more discreet ways to erode purchase price, namely through purchase price adjustment mechanisms embedded into a purchase agreement.

How to Maximize Value
Speed is the key. The biggest factor in losing value through the due diligence process is time. The longer due diligence drags on, the more likely the buyer will find something that, in his mind, reduces the company’s value. Passage of time can also decrease ultimate market value by creating a negative perception for other potential buyers. By preemptively preparing many of the analyses that a buyer will commonly request/perform during due diligence, including an independent Q of E analysis, a seller can significantly shorten the process, reduce the risk of unknown valuation issues, and effectively negotiate purchase agreement language and closing price adjustment mechanisms.

Admittedly, preparation to stay ahead of a buyer takes time that most companies today do not have. An experienced team, including M&A advisors in conjunction with an investment banker or broker, can provide a critical third-party perspective to help create the analyses a buyer will likely require. Focusing on preparation to speed up the process will reduce valuation surprises, help empower contract negotiations and ultimately deliver more value to the seller.

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Cohen & Company is not rendering legal, accounting or other professional advice. Any action taken based on information in this blog should be taken only after a detailed review of the specific facts and circumstances.