Preparing for Sale – Financial Due Diligence

You have considered the pros and cons to selling your manufacturing and distribution (M&D) business and have decided that the time is right to sell.  

Many entrepreneurs fail to realize that proper and timely planning and preparation for the “sell-side” process is critical to consummating a successful, timely, and fairly priced transaction. Preparation and readiness will contribute to maximizing the value of your company and mitigate the risk of surprises at the critical stages of the proposed transaction. 

To ensure a successful and well-executed sale, there are a few considerations to keep in mind:

What to expect during due diligence when you sell your business  

Comprehensive Analysis 

Expect and exhaustive review that spans various elements of your business, including:   

• Accounting 

• Tax 

• Intellectual property 

• Legal 

• Commercial 

• Marketing 

• Environmental 

• Other technical areas  

Due diligence can be onerous and complicated as a buyer/investor attempts to understand, analyze, and properly value your business in the few weeks or months before close. 

Quality of Earnings (QOE)  

A prospective buyer/investor will inevitably ask for comprehensive details underlying your company’s financials to validate the information utilized to make their offer.  

Buyers will analyze your financials “as reported” over past periods and make adjustments to create a normalized view of sales and EBITDA (earnings before interest, depreciation, and amortization). These adjusted metrics serve as the foundation for establishing a value and offer price for a company. 

This in-depth historical and pro forma analysis will likely be completed by a third-party CPA or advisory firm and includes scrutinizing your financial records over a period that could span several historical periods. 

How can you prepare for the financial due diligence/QOE process 

Plan and Allocate 

Transactions often take longer and are more complex than expected. To navigate this process successfully, consider the following:  

• Organize Transaction Teams: Make sure that all due diligence teams – internal and external – are well-connected and aligned. Effective communication is crucial.  

• Choose the Right Project Manager: Appoint and experienced project manager who possesses adaptability, leadership skills, multitasking abilities, and technical proficiency. The project manager can be an internal executive or a third-party specialist.  

Before presenting the information to potential buyers, follow these steps:  

• Sanitize and Vet Data: Review financial records meticulously. Buyers will focus on monthly financial results from the last two to three historical year and the most recent year-to-date interim period. Ensure accuracy and consistency by reconciling significant accounts with subledgers and schedules.  

• Understand Historical Trends: Analyze monthly trends underlying historical results. Identify any unusual or one-time items. Present a “normalized” view of historical earnings to represent the business accurately. 

Organize and Control Information Flow

Create a well-organized and robust electronic data room and comprehensive, excel-based data pack with important and relevant financial, contractual, operational, and legal information, including data analysis and contract abstracts.     

Maintain control of the transaction process, including the amount, timing and detail of information that is provided to prospective buyers. 

Adress key due diligence questions promptly. disclose and address key due diligence questions and data request items. Prioritize information flow to ensure relevance, accuracy, and appropriateness in light of the overall mutual transaction goals and objectives. 

The key external players in an M&A transaction and their roles  

It’s important to engage experienced transaction advisors early in the process who are familiar with the manufacturing and distribution industry and have experience with buy- and sell-side transactions.  

Here are the key players who can guide your company through the process:  

• Investment Banker: Assists the company with identifying potential suitors and advising on realistic, market-based valuation metrics. Helps package, communicate, market, and negotiate your proposed transaction to qualified and interested third parties. 

• Tax Professional: Assists with structuring a tax-beneficial transaction and identifying potential tax pitfalls to both the buyer and seller in contemplated agreements. 

• Financial and Accounting Professionals: Assists with cleaning up financial information, performs sell-side financial due diligence, and assists with the question-and-answer process with the buyer’s due-diligence provider. Generally, an independent CPA firm. 

• Legal Counsel: Assists with the deal documents and negotiations. Counsel should also thoroughly review key contractual terms to determine risk exposure and assist management with the post-close integration and synergy assessment. Should have M&A experience. 

• Insurance Professionals: Most buyers will request an escrow or holdback from the purchase price for potential breaches in representations and warranties in the purchase agreement (typically 10% to 15% of the purchase price for one to two years). By obtaining an insurance policy, the buyer recovers any damages directly from an insurer and the seller receives more of the transaction proceeds when the transaction is consummated. 

How to maximize your financial position during a sell.  

Precision matters when it comes to presenting your financial information during a transaction. To position your business in the best possible light, consider the following:  

Sell-Side QOE Analysis 

Perform a comprehensive quality of earnings analysis that focuses on:  

• Revenue cycle 

• Purchase cycle 

• Normalized earnings  

This analysis can help maximize the value and efficiency of the transaction, and helps you: 

• Avoid surprises through the identification of potential financial concerns that could be raised by buyers and assist with providing well thought out and candid responses as part of the buy-side due diligence question and answer process. 

• Relieve the added pressure and demands on your finance team resulting from voluminous transaction requirements, allowing your finance team to focus on day-to-day running the business. 

• Identify possible positive adjustments to operating income and potential upside in the sale price. 

• Provide vetted, detailed financial information to prospective interested parties in an organized manner which increases confidence in the financial information presented and bolstering the buyer’s perception of your business. 

Navigating the Transaction Journey  

Selling your business is an all-encompassing process which can span a 6–12-month period from onset of negotiations to closing.  

An entrepreneur can significantly improve their chances of a successful outcome by properly planning the overall transaction process and building a team of experienced professionals that can help the entrepreneur navigate through the complexities of the transaction to a successful close.