After Heads of Terms: preparing for due diligence

Once Heads of Terms are signed, the buyer is usually granted a period of exclusivity, often two to three months, to complete its investigations and agree the legal documents. Most of the risk to the price and the timetable sits in this period.

What buyers examine

• Financial. The quality of earnings, the adjustments behind EBITDA, working capital, net debt and the reliability of management information. Often carried out by an accountancy firm on the buyer’s behalf.
• Commercial. Customers, contracts, pricing, pipeline, competitors and the wider market.
• Legal. Company records, customer and supplier contracts, property, employment, intellectual property, disputes and regulatory compliance.
• Tax. The company’s tax history, any open enquiries and potential exposures.
• Operational. Depending on the business: IT systems, health and safety, environmental matters or insurance.

Why deals slow down

Due diligence rarely fails because of a single dramatic discovery. More often, the timetable slips because information takes weeks to assemble, questions arrive in waves, and the owner, who is also running the business, becomes stretched.

Delays matter. They give the buyer time to reconsider, expose the deal to changes in trading or market conditions, and create opportunities for the price to be revisited. Issues a buyer finds for itself also tend to be treated more seriously than the same issues disclosed openly at the start.

Issues disclosed early are a matter for negotiation. Issues discovered late become a matter of trust.

Preparing before you go to market

The most effective preparation happens before Heads of Terms are agreed. In practice, that means having ready:

• up-to-date management accounts that reconcile to the statutory accounts, with clear explanations of any adjustments to EBITDA;
• signed copies of key customer and supplier contracts, with any change-of-control clauses identified;
• employment contracts, an organisation chart and details of any disputes or claims;
• property documents, including leases, licences and any dilapidations obligations;
• company records in order: statutory books, the register of members and Companies House filings;
• a clear understanding of any known issues, so they can be explained on your terms rather than discovered.

Organising this into a well-structured virtual data room allows buyers and their advisers to work quickly, and it signals a business that is well run.

Warranties, disclosure and protecting yourself

In the sale agreement, the seller gives warranties: statements of fact about the business. The disclosure letter is where you set out exceptions to those statements. Matters that have been fairly disclosed generally cannot later form the basis of a warranty claim, which is why thorough disclosure protects the seller. Limits on liability, both in amount and in time, are negotiated alongside. In some transactions, warranty and indemnity insurance is used to transfer part of that risk to an insurer.

Keep running the business

Buyers watch trading closely during exclusivity. A dip in performance while the owner is absorbed by the transaction can lead to a renegotiation. Having an adviser coordinate the process, the information requests and the other professionals involved allows you to stay focused on the business, which is ultimately what the buyer is paying for.

Peter Hogan is the founder of Hogan Capital and has spent almost nine years working with owner-managed businesses, predominantly across mergers and acquisitions. More about Peter or connect on LinkedIn.

This article is general information and does not constitute financial, legal or tax advice. Figures are illustrative.