Due diligence can be grueling for a company at any stage, but the key to making this process as painless as possible and getting the best value is to be organized and ready. If you start to maintain the information now for an anticipated transaction in the future, the level of disruption with respect to your normal duties should be minimized, and you can avoid due diligence becoming your full-time job.
An important concept to remember is that the acquirer wants details on where the company has been, what the company owns and owes and where the company is going. Typically, an acquirer will request historical information for up to three years and projected information for at least one full 12-month period. Upfront transparency on issues and numbers is important to avoid a negative purchase price adjustment.
Here are our top suggestions for a smooth due diligence process and maximizing your purchase price.
An acquirer will hire a team to dig into your numbers, so you should be prepared to explain the rationale behind accruals, any one-time expenses and reserves. It is very important that cutoff procedures are in place so the company is already capturing revenue and expenses, including chargebacks for trade spend, in the proper period. Failure to do so can result in a purchase price adjustment. Additionally, it is important that one-time or unusual expenses are properly segregated so they can be a positive adjustment to the purchase price, if warranted.
An acquirer wants to know commitments included in various contracts. These commitments range from future debt and lease payments, purchase and sales commitments, or arrangements made under a royalty agreement. A good practice in preparation for due diligence is to summarize your major agreements with lenders, lessors, vendors and customers including a schedule of future minimum payments. The commitments should be reviewed and accruals should be made where necessary, in order to avoid a purchase adjustment and to show that your balance sheets and any off balance sheet items are accurate.
An acquirer will want to know the different classes of capital and the rights and privileges for each class. Before starting the due diligence process, you should have an accurate cap table, understand the rights of each class and the effect a sale will have on each class. If your company has issued equity-based incentive units, you should consider these instruments and their share of the sale price when determining your ideal sales price. If there are negotiations that need to take place with different classes of equity holders, have them early in your process.
Even when a sale is not on the horizon, it is a good business practice to be able to track your business by channel, customer and SKU to make educated business decisions. A typical acquirer will want to see detail showing the history of gross profit by each of these categories as well as other costs affecting the final contribution margin of each (i.e. distribution and warehousing costs). You should be able to present promotional spend by customer and by SKU. You should be ready to provide the buyer with a plan for gross profit improvement, if any, and the projected sales and promotional calendar for the upcoming year. Lastly, you should have a narrative along with a budget illustrating what will drive your sales growth in the next three years.
It is never too soon to start addressing the impact on your financial statements of adopting Generally Accepted Accounting Principles (GAAP). Once you have more sophisticated or larger investors on board, it is recommended that a review be performed by a reputable independent CPA firm so the financial statements become compliant with GAAP, including all required disclosures. An audit is advisable when you believe a major transaction is no more than two to three years away. Additionally, a significant amount of information is often requested as part of the due diligence process for the preparation of the financial statements. Having this information properly prepared and readily available enables your accountants to take the burden off of your team by providing a large amount of data to the acquirer’s due diligence team.
The acquirer will expect a complete understanding of all jurisdictions in which the company is doing business. You should consult with your attorneys and your tax advisors on appropriate actions to take with respect to each jurisdiction. Also, as more and more states move toward “market-based sourcing,” your company may have filing requirements in certain states even if you do not have an employee or store inventory there. In addition, there are many states and cities with activity, license or privilege taxes that can crop up on diligence. Therefore it is advisable to engage an accounting firm well versed in these matters.
Being prepared and having the right team to support you is the key to simplifying the due diligence process and avoiding surprises before a transaction closes. With the current activity level in food and beverage and consumer products, maximizing the value you have created is the key to closing deals successfully and realizing your exit strategy.
Greg Wank, CPA, CGMA, is a partner and leader of Anchin’s Food & Beverage Group and co-leader of Anchin’s Consumer Products Group; Raymond Baggeri, CPA, is an assurance and transaction advisory partner in Anchin’s Food & Beverage and Consumer Products Group; Megan Klingbeil, CPA, is an assurance and transaction advisory director in Anchin’s Food & Beverage and Consumer Products Groups.