Sell-side due diligence, or valuing the company’s assets and examining and documenting the health of the organization, is a fundamental component of the sale process. This procedure, even for small businesses, will help drive a selling price that satisfies ownership while reassuring a buyer of sufficient return on investment.
There are many methods for valuing an organization, although the eventual selling price is always based on the value perceived by the buyer. Two common methods are Asset Valuation and Market-Based Valuation.
This approach is common when a business is being sold for liquidation, as the assessment identifies the potential selling prices for used equipment, facilities, inventory and real estate. This approach also applies to businesses being transferred to new owners for operation, in which case intangible assets can greatly impact overall corporate value. For example, a business with few physical assets might hold intellectual property that hasn’t yet been commercialized, or it may have long-standing customer agreements that can be reinvigorated with new products and new sales practices.
This approach looks at the value of the business from the next owner’s perspective – it identifies how much value the company will continue to generate. Market valuations examine the value of similar companies and their assets, and then establish a multiplier driven common for the market or industry, such as a multiple of sales or earnings before interest and taxes. For smaller businesses, this may be a multiplier of the seller’s discretionary earnings, which consists of the business’ profit plus benefits to the owner (e.g., salary or nonrecurring expenses).
Sell-Side Due Diligence
With valuations as their basis, sellers seek to convince potential buyers of the business’ worth. Sell-side due diligence looks for both issues that negatively impact sales price, allowing the seller to counteract them to support the desired valuation, and hidden positive features that may boost sales price.
Sell-side due diligence should address:
- Business basics – Document the company’s financial history, including earnings, cash flows, debts, and obligations.
- Working capital requirements – Identify requirements to maintain current and future business performance (to drive ongoing operations) or to close down the business (to assist the liquidation).
- Sales forecasts – Quantify future business demand, relying on contracts, market forecasts and realistic sales-staff expectations. This analysis should differentiate by products, markets, distribution channels and customers (e.g., a high sales forecast for a large, growing customer can offset tepid forecasts elsewhere).
- Business relationships – Affirm that business is not driven by personal relationships that will end when the current owner exits. The seller will also need to reassure the buyer that favored pricing and performance levels with suppliers will survive the transaction.
- Accounting practices – Detail procedures and assumptions in a manner consistent with industry standards.
- Risks – Smart sellers quantify risks in anticipation of buyer concerns, e.g., “What if a competitor releases a superior product? What if the senior leadership team retires? What if a new law/regulation/tax is passed?”
A willing and prepared seller is only one half of a transaction – and a long way from a done deal. Sellers need buyers, as well as a path to negotiate and close a deal. Check back for the final article in this series, “Executing the Sale”.