Affecting pricing through lengthy due diligence processes

Time really is money. In a recent BVCA panel, Cass Business School and Intralinks presented the latest findings related to their previously published report, When no-one knows: pre-announcement M&A activity and its effect on M&A outcomes. Scott Moeller, a director in the M&A Research Centre at Cass, and Philip Whitchelo, the vice president of strategy and product marketing at Intralinks, noted that a longer due diligence process results in higher long-term shareholder returns for the buyer. The research reveals the longer the due diligence process, the more likely a buyer will uncover information that can be used as a negotiating tool in price discussions.

This means, of course, that takeover premiums for sellers can be significantly lowered. While this is a boon for private equity firms as buy-side financial sponsors, it also means a GP has to be wholly prepared when beginning the sale process for a portfolio company of its own.

Private equity firms can implement strategies to keep the due diligence process of potential buyers short when divesting a portfolio company. One way of doing so is by launching a pre-emptive selling strategy months in advance of beginning a sale process, so by the time a buyer's due diligence process begins, the seller is fully organised and confident they will be able to achieve their price expectations.

"There's an opportunity to plan thoroughly and get your ducks in a row well before the sale process," says Alvarez & Marsal managing director Colie Spink. "Sellers need to get the business plan and supporting data organised so that a bidder can quickly get their head around it and see the direct links between historical and forecast financial performance. They need to be able to see the story and get comfortable with it.

"But well before data preparation, a seller needs to start thinking strategically about the key commercial and operational aspects of their business that potential buyers will value. What are the things that might cause a company to pay a premium for the business?"

Quality not quantity
DC Advisory managing director Simon Tilley goes through the firm's strategy to potentially shorten the due diligence process: "Our style of running processes is preferably to have fewer but better qualified bidders, rather than lots of potentially qualified bidders, so that we can provide diligence earlier in the process rather than later."

This style of managing a sale process means that potential buyers are better equipped to make first-round bids, says Tilley, rather than just having a management presentation or information memorandum to go by. This means a seller can then "select the bidders to take through to a short, sharp second round with more confidence".

"Our process is much faster," Tilley says. "It does require front-loading of work, so it requires getting the due diligence providers on board earlier in the process, but it then enables you as the seller to make sure that all of the documentation that you provide to buyers is consistent."

This method means the information memorandum, management presentation and due diligence reports are all drafted at around the same time, which allows for consistency across a company's message in those transaction documents. "If you write an information memorandum early and then commission due diligence two months later, you have less control over the consistency of that messaging," says Tilley.

While consistent, this information also needs to show the company in its best light, which is why Spink believes strategic planning needs to begin well in advance of data organisation: "If you're a seller, you need to expect that your buyers are going to carry out diligence on the information you give them – so you need to be able to demonstrate and back up your claims. Well in advance of the sale process, a company should consider what factual evidence currently exists that supports its claims – and whether or not the company can take steps to strengthen that evidence. This will mean that when a buyer conducts due diligence, the prospective target gets a big tick in the box and the seller gets the premium value that it is hoping for."

However, the Cass/Intralinks report outlines the methods some sellers may use if they have not prepared a company for exit by making strategic or commercial changes, or simply if a company is far less attractive an asset than they would like it to seem. If this is the case, sellers may try to limit the due diligence due to a longer process being advantageous to a potential buyer in that it has more time to dig up dirt on the company.

Sneaky leaky
According to the report, one way for sellers to gain some control over the process – and to potentially keep the due diligence process short – is intentional leaks of potential deal-doing. This can create competitive tension and could goad some bidders into abandoning a more lengthy and detailed due diligence process for fear of losing out on an asset.

However, this method can backfire. "I don't think media hype to telegraph an imminent sale is necessary," says Spink, "and in fact, sometimes it can be quite unhelpful. It's very distracting to the management team and it's unsettling to the broader team. Change of control is a massive strain on the organisation, so getting people worked up about it before it happens is not necessarily a good idea. It could also invite an unwanted enquiry, or opportunistic people coming along trying to buy it on the cheap. It's better to keep control of a process."

The Cass/Intralinks report states strategic bidders are more likely to rush a due diligence process in the case of a competitive bidding scenario. On the contrary, deals with a financial sponsor on the buy-side take 30% longer to complete, according to Whitchelo, speaking at the recent panel.

Spink notes that buy-side private equity firms are also increasingly realising the importance of operational due diligence: "Where firms are doing a leveraged buyout of a stand-alone company, we've seen a rather dramatic increase in their need for operational due diligence. Not because they're looking to combine the business with something they already own, but because they need a plan to create value in the company that they're buying. They're trying to figure out what the equity story is."

Delving deeper into due diligence – and taking the time to comb over fine print, when possible – may be the answer to negotiating a favourable acquisition price for GPs, but keeping the due diligence process short when trying to sell a portfolio company is the best way to achieve a favourable selling price. In either case, impeccable planning, utmost confidence, and consistency in reporting are the key ingredients to a swift due diligence phase and rewarding sale process.

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• Topics
• Investments
• Buyouts
• Advisory
• Due diligence
• DC Advisory Partners
• Alvarez & Marsal
• Unq2015Jan