Sellers Due Diligence: How and why you need to investigate your buyers
O*NO! You’re in the process of selling your business, shares, and/or assets and a potential buyer has approached you – however you don’t know much about them. This can sometimes spell trouble for your sales transaction, because a problematic buyer could cost you time and money. Here’s where due diligence takes centre stage. By undertaking a sellers due diligence you can investigate potential buyers, allowing you to eliminate ‘bad buyers’ and making informed decisions to maximise your transaction value. This blog is all about the sellers due diligence process, with a look at what it is, what it involves, and why you need it.
What is due diligence?
Due diligence isn’t just a buzzword; it’s the compass guiding your decisions. Imagine you’re selling your beloved antique shop—the one with creaky wooden floors and stories woven into every teacup. Before handing over the keys, you want to know who’s stepping into your nostalgic world.
Due diligence is a comprehensive investigation to assess risks, uncover hidden issues, and make informed choices. The due diligence process is typically associated with buyers who engage in the process to verify the claims made by the seller regarding the assets to be sold. This is particularly prevalent in transactions involving rent rolls, agency shares, and property/asset acquisitions.
Sellers due diligence: What is it and why do I need to do one on a buyer?
In essence, your goal when engaging with potential buyers will be to find those that are serious about the purchase and qualified to complete the transaction without hurting your bottom line, which may include matters related to their financials, working ability, or even reputation.
Often we may decide to just go with the buyer offering the highest sale price. However, this may not be the most beneficial in the end. Let’s say you forgo due diligence with a rent roll sale, and later, you discover a purchaser who is disinterested in the new business or problematic. This could result in heavy lost managements, which then means your final sale price is impacted.
There are many other benefits of doing a due diligence check on your potential buyers, including:
Risk Mitigation: You can identify, and mitigate, potential risks associated with the buyer, such as past failed transactions.
Interest: You can gain insights into the buyer's intentions, plans, and motivations, which can guide you towards a buyer that aligns with your objectives.
Financial stability: You can determine if the buyer has the necessary resources to actually complete the sale.
Leverage: Knowledge about a buyer and their situation can give you increased bargaining power.
Reputation: You can avoid association with people/brands with bad reputations, which can harm you in your personal and professional capacity, especially if your name is attached to the agency, or if you are a part of a larger brand (ie. franchises).
Transaction Confidence: Knowing that you are transacting with a reliable and credible buyer will give you peace of mind of a smooth and protected transaction.
What are some key steps involved in a sellers due diligence?
1. Financial Due Diligence
Balance Sheets and Income Statements: This is important, especially if you are selling a large asset like a business or rent roll portfolio, because you need to know if the buyer has the financial ability to pay you and satisfy other conditions to the sale (ie. transfer of guarantees).
Liquidity and Solvency: Check the buyers liquidity, to determine their ability to handle short-term risks, and their solvency to determine their overall financial health.
Red Flags: Watch out for debt overload, dwindling cash reserves, or creative (ie. incomplete, misleading) accounting.
Expert: It’s pertinent to get this right – don’t get misled by wrong numbers or calculations. Here, we recommend bringing in your accountant or financial advisor to undertake the financial due diligence.
2. Legal Due Diligence
Licenses and Permits: Are they licensed in the industry? Will they be able to continue business operations once takeover happens? Verify licences and regulatory compliance.
Pending Legal Liabilities: Any lawsuits or large insurance claims coming their way? Uncover pending legal matters and other liabilities.
Legal Advisors: Bring in the experts. Given the complexities involved, do it right by having it done by legal experts. For greater peace of mind have your legal due diligence done by legal advisors who have experience in your industry (PS. our team of real estate agency lawyers can help).
3. Operational Due Diligence
Business Operations: Understanding how they move through business processes. What’s their customer relationship like?
Landlord-to-PM Ratio: Evaluate their landlord-to-property manager ratio. Do they have enough support for the potential incoming acquisition? Any flight risks? What are their processes like? Will your staff (if taken across) fit in with the culture of the business?
4. Risk Assessment
Market Risks: Are they dancing on a tightrope in a volatile market?
Industry-Specific Risks: Every industry has it’s own risks – so you need to be aware current situations that may cause this deal to fall over.
Reputation Risks: Gossip travels fast and can have a significant impact on you, personally and professionally. Investigate your potential buyers reputation, understand what others in the industry are saying about them, and get NDA’s signed!
5. Background Checks & Interviews
Individual Spotlight: Background checks on key individuals—directors, shareholders, and beneficial owners.
Stakeholder Interviews: Chat with their management team. Is everyone on board?
Creating a Due Diligence Report
Putting your due diligence findings in a synthesised reports will provide you a comprehensive understanding of your potential buyer, allowing you to make an informed decision. It will also allow you to adequately address any red flags or risks you have identified, including conversations about key issues internally and with the buyer, speaking with your expert advisors (eg. lawyer or accountant) first, and leveraging your findings in negotiations to achieve more favourable terms.
Key Takeaways:
As a seller, you can perform a due diligence on potential buyers to guide your sales decisions, and vet out the ‘bad’ or unqualified buyers, generally before you expend your time and resources on them.
By performing a sellers due diligence You can identify and mitigate buyer associated risks, gain insight into the interests and intentions of a buyer, determine their financial capability, protect yourself and your reputation, have negotiation leverage, and transact with confidence knowing you’ve made an informed decision.
Remember – sometimes the buyer offering the most money upfront, may not be the best for your bottom line in the end. This is most common with rent roll sales where buyers with misaligned objectives or interests can cost you with lost managements.
A thorough sellers due diligence will involve a team of experts (ie. real estate, legal, financial) performing analysis over a range of areas including the buyers financial, legal, operational, and reputational situation.
Your Next Steps
Thinking about selling your agency or rent roll, and have potential buyers in the running? Protect yourself by doing your legal due diligence with the RE agency law experts – book your FREE 10 min chat to find out how we can help.
Boring legal stuff: This article is general information only and cannot be regarded as legal, financial or accounting advice as it does not take into account your personal circumstances. For tailored advice, please contact us. PS - congratulations if you have read this far, you must love legal disclaimers or are a sucker for punishment.