The cost of non-compliance in the sale of a business – How vendor due diligence can help.

For many privately owned companies the sale of a business is a significant milestone on both a personal and professional level. Following years of hard work with a vested interest in making the company successful for various reasons the timing is now right to sell and whether going through a formal sale process or having identified a buyer the company is now at the final stages of negotiating a price for the sale. It is, however, worth noting that upon agreeing a price and high-level terms the sale process still has a long way to go.

Buyers will more often than not undertake due diligence procedures on the seller’s business. This due diligence could be done through in-house resources or through external providers. Due diligence done well can add significant value to the transaction and for those sellers not prepared for the result can be a large reduction in the selling price.

Broadly due diligence will cover:

• Financial due diligence is an analysis of the financial performance of a company. It is conducted to gain a better understanding of the financial situation, the historic performance, and its prospects for the future.
• Tax due diligence - Tax diligence covers not only income taxes, but also all the other indirect taxes such as VAT, withholding tax, payroll, and employment taxes. The tax due diligence covers historic compliance with regulatory bodies.
• Legal due diligence is a key investigative process in which the buyer carries out a review of the legal profile such as ownership of assets and associated pledges of security, certificates, and licenses to trade.
• Other due diligence processes can be specific to the type of business being acquired and cover areas such as environmental, social and governance, commercial, human resources, and IT.

Outcomes in the due diligence process often relate to price adjustments to the valuation of the business, conditions that need to be satisfied prior to the transaction taking place and representations and warranties, all of which are covered ultimately in the purchase agreement.

Price adjustments are often identified through the financial due diligence process. These can be found in different ways:

1. Adjustments relating to the earnings profile of the seller.
2. Adjustments relating to items of debt that require repayment before or at settlement date; and
3. Adjustments relating to the fact the business does not have sufficient working capital.

However, one thing is for sure is that where a business has been non-compliant with relevant laws and regulations then fixing these issues is a true cost to the seller will have to borne prior to a deal happening. They are often covered in the conditions precedent of the sale. If the non-compliance is significant then they could in fact be a deal breaker. Knowing about these issues prior to a sale process can be the difference between a deal happening on a timely basis or not at all. Vendor due diligence can help here.

Vendor due diligence is where an external party is engaged prior to going to market for a sale to identify and then reassure potential buyers or future business partners that their investments and relationships are financially sound and profitable, and there are low levels of associated risk across the entire organisation. The scope of work is tailored and agreed to suit the specific circumstances and requirements of a client and/or transaction and allows an opportunity for the seller to identify these issues and fix them prior to the sale. In doing so the risk of transactions failing is much lower. If you would like to speak to a BDO expert, please do get in touch today.