Managing Due Diligence After the Letter of Intent

The execution of a Letter of Intent marks a significant transition in the M&A process. At that point, the selected buyer typically receives exclusivity. The seller stops discussions with other prospective buyers while the selected buyer completes confirmatory M&A due diligence. Therefore, the transaction enters a different negotiating environment.

Before the LOI, multiple buyers may compete for the opportunity. That competition may strengthen the seller’s negotiating position on price, structure, and other terms. After exclusivity begins, that competitive pressure disappears. The buyer then conducts an extensive review before signing the definitive purchase agreement and closing the transaction.

The primary purpose of confirmatory M&A due diligence is to verify the information presented during the sale process. Buyers also investigate risks that could affect their investment. The review generally covers several major areas:

• Financial: Revenue, earnings, normalized EBITDA, working capital, receivables, inventory, debt, and financial projections.
• Legal: Contracts, corporate records, litigation, intellectual property, licenses, insurance, and regulatory compliance.
• Operational: Facilities, equipment, technology, systems, suppliers, processes, and capital expenditure requirements.
• Commercial: Customers, concentration, retention, pricing, competition, market position, and growth opportunities.
• Human Resources: Management, employees, compensation, benefits, agreements, and organizational structure.
• Tax: Income, payroll, sales, property, and other applicable tax matters.

The buyer may also conduct specialized reviews involving cybersecurity, environmental matters, insurance, or other industry-specific risks. During diligence, the buyer compares its findings with the information provided before signing the LOI. Significant differences may create problems for the seller. For example, declining earnings may challenge the assumptions supporting the purchase price. Customer losses or unexpected liabilities may create similar concerns.

In response, the buyer may seek a price reduction, additional escrow, stronger indemnification, or other changes. Significant findings may also prevent the transaction from closing. This possibility makes preparation before the LOI critical. Sellers should identify potential diligence issues before prospective buyers evaluate the company.

Financial statements should reconcile with supporting records and income tax returns. Contracts, employee matters, customer concentration, ownership records, and other significant issues should receive similar attention. When possible, the seller should correct problems before beginning the sale process. Otherwise, material issues should receive appropriate disclosure before the buyer receives exclusivity.

This approach protects credibility and reduces the likelihood of unexpected discoveries during confirmatory M&A due diligence. It also helps preserve the economics negotiated during the competitive process.

An experienced M&A advisor should anticipate diligence issues well before selecting a buyer. Careful preparation allows confirmatory diligence to validate the transaction rather than become an opportunity to renegotiate it.