Seller’s Market: Financial Due Diligence Questions to Ask

How do you know whether your business is prepared to be sold? The most important questions must be answered to make selling as easy as possible. A checklist can assist managers in planning their sales.

Due diligence on financials (FDD) is now an integral element of mergers and acquisitions. This article is aimed at business owners who may be considering selling their company (or some of it) over five years. It will aid them in assessing the business’s readiness by answering the most critical FDD questions. Buyers can also utilize the same data to determine warning signs in a prospective buyer. You can refer to the glossary near the end for clarification of terms.

This article will walk you through a broad questionnaire designed to aid a prospective seller in determining if their company is (and consequently, to sell). This is not a replacement for thorough, customized financial diligence and is not intended to provide financial advice. The purpose is to convince the management of the vendor to begin contemplating selling their business and to provide my experience with the FDD procedure. FDD cannot be considered an audit or assurance service and does not guarantee complete protection from fraud or the misrepresentation of management.

Are You Ready for Sale?

Take your time with the following seven questions. Each question should be scored according to the scoring guidelines (a max of 10 points on each one). If you are selling just a small portion of the business, think about the entire part as a “standalone” business:

Does the company have a strong finance manager?

I was a part of an FDD of a medium-sized company (business A), which didn’t include a financial director. The business was increasing. However, the finance department was not kept up. We had difficulty obtaining the same information consistently, which resulted in warnings (e.g., data quality was deemed poor, resulting in the pressure on sellers to support their claims by legally binding representations of management or clawback agreements). The business was eventually sold on a strategic basis. However, it was not until the purchaser negotiated the most significant reduction (the price of having a good finance team was included as an adjustment to the Quality of Earnings, and remedial clauses were contained within the SPA).

Exclusions and solutions

Suppose the desired goal is small and cannot afford the expense of a significant hire at the present stage in development. In that case, it may be beneficial to include a person with a solid financial background for the next 2-3 years, ideally until the anticipated date of the deal, or employ qualified consultants on a part-time basis to help develop a plan for the selling process, improving the overall quality of the financial data and getting ready for the sale.

What are financial data’s current strengths and the systems that underlie it?

A solid IT system supports consistent, reliable, pertinent numbers with sufficient depth. For instance, when a company depends on traded commodities, such as metal, the numbers must show how the management manages the fluctuation in cost or how efficiently they can transfer the cost to clients. The numbers should speak about the selling pitch and assist buyers in understanding the most critical risk.

Due to having dealt before this, small private equity companies (business B) had high-quality information that FDD advisors could use. It included monthly figures for the past three years. It also had audited financials with detailed breakdowns and an accurate reconciliation between audited and management accounts. The data was all sourced from software for accounting (vs. Excel spreadsheets) with strict access controls to avoid any unwarranted manual intervention and ensure accuracy and source. This allowed us to quickly end the project and provide the most precise (positive) perspective on the quality of the information.

Remedies and exceptions

If you must choose between quality and quantity, choose the highest quality. Tight quarterly numbers are superior to the erroneous monthly numbers.

The company accounts are compiled by using an industry-standard program. 1.5 points (zero for Excel only).

If there aren’t any audited accounts reconciliation between management accounts and the operational system used to generate precise schedules (e.g., CRM, warehousing software, etc.), 0.5 points if it works.

Detail breakdowns of the most important line items that can be reconciled with principal accounts 0.5 points if management is confident in performing this on more than 50 percent of line items

How well does the current management team monitor the goal?

What are the primary elements of the company? Take a look at the management data and important metrics for performance (KPIs) that the management employs to monitor profits, expenses, revenue, cash flow, covenants, and working capital.

Effective monitoring systems will allow the management to handle diligence-related concerns quickly.

A keen awareness of and ability to communicate essential trends in your business (e.g., high costs, which are growing in the market, etc.) and a keen understanding of substantial risk factors (e.g., FX raw materials, regulations, or covenants). The existing system for business intelligence will suggest active management.

Management from Business B met monthly to discuss the current play and determine the best way ahead. The CFO office was aided by a knowledgeable team that utilized Tableau to display the data in various ways and possibly spot any unusual changes in the figures. As expected, as the diligence team was trawling through the financial records, the management was comfortable and speedy in describing the key developments.

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