Tag Archive for: DueDiligence

Managing Confidentiality Throughout a Business Sale

/in /by

Selling a privately held business requires sharing sensitive information with prospective buyers and their advisors. At the same time, premature disclosure may create significant disruption. Employees may worry about their jobs. Customers may question future relationships, while competitors may use the information to their advantage.

For these reasons, protecting confidential business information requires more than signing a nondisclosure agreement. Confidentiality should guide the entire sale process.

Controlling the Initial Disclosure

The M&A advisor should initially approach prospective buyers without identifying the seller. A blind teaser may describe the opportunity while protecting the company’s identity. Interested buyers should then demonstrate sufficient credibility before receiving additional information. Qualified buyers typically execute a confidentiality agreement before learning the company’s identity.

Once that threshold is met, the advisor may provide the Confidential Information Memorandum and other appropriate materials. Even then, sellers should not disclose every sensitive detail immediately. Information should become progressively more detailed as buyers advance through the process.

Managing Employees and Business Relationships

Employee disclosure requires particular care. Some owners involve selected executives early, while others maintain confidentiality until much later. Neither approach fits every transaction. The appropriate strategy depends on management responsibilities, transaction needs, and the potential consequences of premature disclosure.

Customers and vendors generally require similar discretion. Early disclosure could create uncertainty and potentially affect valuable business relationships. For competitive buyers, confidentiality requires additional attention. Customer lists, pricing, margins, proprietary processes, and other competitive information may require restricted access. The seller may delay particularly sensitive disclosures until later due diligence. Redacted information or aggregated data may also provide buyers with necessary information while reducing exposure.

Maintaining Confidentiality Through Closing

Confidentiality does not end after a buyer signs an agreement. Sellers should continually evaluate who receives information and why they need it. A Virtual Data Room may provide controlled access and maintain an organized record of shared information.

As the transaction progresses, disclosure naturally expands. However, each stage should provide only the information reasonably necessary for the buyer’s evaluation. An experienced M&A advisor helps manage this progression while coordinating with the seller’s legal counsel. Protecting confidential business information requires discipline from initial buyer outreach through closing. The objective is simple: provide buyers what they need without unnecessarily exposing the seller’s business.

Operating the Business Between LOI and Closing

/in /by

Signing the Letter of Intent represents a significant transition in the sale process. The buyer receives exclusivity, but the seller still owns the business. During this period, the seller must continue operating the company while the parties complete due diligence and negotiate definitive agreements. For that reason, LOIs often require the seller to operate within the ordinary course of business. The purchase agreement will typically address these obligations in greater detail.

What Does Ordinary Course Mean?

The ordinary course of business generally means operating consistently with the company’s established practices. Management should continue serving customers, paying vendors, managing employees, and making routine operating decisions. The objective is not to prevent management from running the business. Rather, the provision protects the company underlying the buyer’s offer. The buyer expects substantially the same business at closing that existed when the parties signed the LOI.

Decisions That May Require Additional Attention

Certain actions may change the company’s financial condition, operations, or future earnings. Therefore, sellers should carefully evaluate significant decisions during the period before closing. Depending on the transaction, these actions may include:

  • Making significant capital expenditures
  • Increasing owner or employee compensation
  • Hiring or terminating key employees
  • Entering significant customer or vendor contracts
  • Discontinuing products or service lines
  • Changing accounting policies or practices
  • Incurring additional indebtedness
  • Selling significant operating assets
  • Making unusual distributions to owners
  • Changing pricing or customer credit policies

During this interval, sellers should communicate unusual decisions to their M&A and legal advisors before taking action.

Protecting the Transaction Economics

Ordinary course operations may also affect the balance sheet delivered at closing. Working capital provides a common example. The parties may establish a normalized working capital target during negotiations. Changes in receivables, inventory, payables, or accrued expenses may affect the closing adjustment. Against this standard, sellers should avoid manipulating working capital to increase cash distributions before closing. Buyers will examine whether the company maintained normal operating practices. The same principle applies to earnings. Delaying necessary expenses or accelerating revenue may create diligence concerns and undermine buyer confidence.

Managing the Period Before Closing

Operating within the ordinary course of business does not require freezing the company. Businesses must continue making decisions and responding to changing conditions. Instead, sellers should maintain consistency and communicate material deviations before acting.

An experienced M&A advisor will coordinate these issues with transaction counsel and the seller’s accounting professionals. This coordination helps protect the negotiated economics and reduces unnecessary closing disputes.

What Buyers Are Testing During Due Diligence

/in /by

A buyer does not conduct due diligence simply to collect documents. The process tests the assumptions supporting the proposed transaction. Before signing the Letter of Intent, the buyer develops expectations about the company’s earnings, operations, risks, and future opportunities. The buyer due diligence review determines whether the available evidence supports those expectations.

Validate the Financial Performance

Financial diligence examines the quality and sustainability of the company’s historical earnings. Buyers typically review financial statements, tax returns, monthly results, working capital, debt, and capital expenditures. They may also examine customer profitability, margins, revenue recognition, and the normalizing adjustments.

As financial scrutiny increases, buyers compare information from different sources for consistency. Material discrepancies may affect normalized EBITDA, purchase price, working capital, or other transaction terms. A Quality of Earnings analysis may provide additional financial diligence, depending on the transaction.

Understand the Business Behind the Numbers

Financial performance represents only part of the buyer’s analysis. Commercial and operational diligence examines how the company generates revenue and whether that performance appears sustainable. Buyers may evaluate customers, suppliers, employees, management, competition, backlog, technology, facilities, and operating systems.

They may also test assumptions concerning growth opportunities and potential synergies. Through this examination, the buyer develops a clearer understanding of the risks and opportunities underlying future performance.

Identify Legal and Transaction Risks

Legal diligence examines the company’s contractual relationships, ownership, compliance, and potential liabilities. Transaction counsel may review customer agreements, leases, employment matters, intellectual property, litigation, licenses, and corporate records.

The findings may influence transaction structure, representations, warranties, indemnification provisions, and closing conditions. Tax, environmental, insurance, information technology, and other specialized reviews may also become necessary.

Investigate the Exceptions

A comprehensive checklist provides structure, but effective diligence requires more than completing a standard document request. Buyers should investigate unusual trends, inconsistencies, and potential risks specific to the company. When an issue surfaces, the buyer must determine whether it changes the original investment thesis. Some findings require explanation. Others may lead to additional diligence, revised terms, or a decision not to proceed.

Prepare for Buyer Scrutiny

An experienced M&A advisor should anticipate the buyer due diligence review before taking a company to market. The advisor can help organize information, identify likely questions, and coordinate responses among the seller’s transaction team.

Preparation cannot eliminate legitimate business risks. However, it can prevent avoidable surprises from undermining buyer confidence after the LOI. Due diligence should confirm the transaction the parties negotiated. When it reveals a materially different business, the transaction may need to change.

Allston Advisory Group is an experienced boutique M&A advisory firm providing a variety of services to lower middle market companies. See our footer for contact information.

(502) 742-2933
[email protected]
P.O. Box 21266, Louisville, KY 40221

Our Newsletter

Follow us: