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Sell-Side Due Diligence Report Checklist and Guide for M&A and Other Transactions

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A transaction on the horizon means it’s time to put your best foot forward. You have to dot all your I’s, cross those pesky T’s, and generally put an appealing but accurate sheen on your enterprise. After all, you’re not the only company that’s caught the attention of the M&A crowd, so it’s incumbent upon you to wow that investment group and convince them that it’s your company, not the ones down the street, that deserves the spotlight.

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Unfortunately, that’s where things tend to get a bit murky for the typical seller. With so much to prepare for, a laundry list of questions to answer from potential buyers, and a disconcerting lack of reliable information for sellers, it can all be a bit overwhelming. However, that’s where having an ace-in-the-hole like Embark can be so beneficial, providing both guidance and real-world, tangible help that you can put to immediate use.

For any organization beginning the often laborious and stressful process of attracting a merger, acquisition, or even investment capital, we’re here to offer you a two-fer for the ages – a detailed checklist to make certain you’re addressing all of the items critical to a seller’s due diligence process as well as our sage guidance and best practices to use throughout the process. Suffice it to say, a specific and deliberate approach can not only help organize your financials as you prepare for a full due diligence report and possible transaction, but also allow you to state your case on why your organization is worth the M&A attention in the first place.

Download: sell-side due diligence report checklist

 

Overview

As you’ll see after downloading our due diligence checklist, Embark suggests that sellers complete a wide range of tasks that ultimately address specific topics within your due diligence report to investors. While we designed our checklist to be flexible enough to adapt to virtually any due diligence report, sellers are well-served including the following topics/sections in their report for buyers:

  • Executive Summary
  • Quality of Earnings
  • Working Capital
  • Income Statement
  • Balance Sheet
  • Supplemental Analysis

Remember that these topics are not intended to adhere to GAAP standards but, instead, concentrate on revenue, EBITDA, and other non-GAAP data and metrics important to any buyer or investor. The subsequent comprehensive report toes the line between highlighting the most attractive aspects of your organization, and reliable, quantitative insights that prospective buyers use as part of their decision-making process.

You want to be flattering to yourself but authentic, demonstrate what makes your company unique and worthy of the attention but unfailingly accurate and truthful. Granted, this isn’t the easiest balance to find, but that’s why we’ve prepared our due diligence checklist and these best practices in the first place. In fact, our checklist feeds into the data points that third parties use for reports when potential buyers hire them to conduct their financial due diligence on sellers.

How’s that for real-world, practical insights? In other words, our checklist helps make sure you have your ducks in a row before assembling your report or even contacting a broker for that matter. So on that note, let’s dive into the most common report sections to give some context to our detailed checklist.

Executive Summary

The term elevator pitch has entrenched itself within the business vernacular thanks to its tremendous utility. Think of the executive summary section of your financial report to buyers as your elevator pitch, a concise synopsis that summarizes all of the key items within the diligence report that might impact the deal, from the different metrics and statements included to any other information that might distinguish your organization.

Find a balance between brevity and thoroughness in your executive summary, viewing it more as a snapshot for the rest of the report rather than a source of deep insight. Like it or not, your company most likely isn’t the only one that the prospective investors are interested in, meaning there’s a lot on their due diligence plate. Therefore, just assume that a firm will not read the entire report but, instead, take their time with the executive summary and take a deeper dive into any particular sections that might pique their interest.

Quality of Earnings

Embark uses the Quality of Earnings (QOE) report to begin the quantitative sections of the presentation to buyers or investors. It serves as an insightful companion piece to the income statement and working capital sections, revealing a clearer picture of your operations and financial stability.

This is mainly accomplished by eliminating non-recurring items like large compensation bonuses, one time purchases, or nearly anything else that isn’t a part of your normal operations yet skews your financial statements. The QOE gives you the chance to explain those one-off items, justify their exclusion, and provide your financial suitor with a more accurate perspective of your operations and EBITDA. For a deeper dive into the Quality of Earnings report and some salient best practices, take a look at our previous musings on the topic that includes a walk-through of a sample report.

Working Capital

No matter the industry, your net working capital is going to be upfront and center throughout negotiations. It’s a uniquely insightful report that, ideally, will provide you with a defense against purchase price erosion. As the old saying goes, cash is king, and although working capital isn’t as directly impactful as a proof of cash report, it goes a long way in demonstrating your short-term ability to cover your obligations.

To that point, robust net working capital gives the seller leverage. On the other hand, working capital that isn’t quite up to snuff with respect to industry standards works against you in the purchase price department. Therefore, your net working capital personifies our earlier statement, needing to make your operations look as healthy as possible without stretching the truth. Knowing that a potential buyer will scrutinize each and every line, prepare in advance to maximize the positive impact of your working capital on the purchase price.

Income Statement and Balance Sheet

There’s nothing terribly earth-shattering about the Income Statement or Balance Sheet sections of your financial report to potential buyers or investors. They are, however, the ideal place to provide insights and in-depth perspectives that might get lost in the sea of line items within your audited financials.

For the Income Statement, this is the chance to tell the story behind those line items, to flesh out the numbers with additional information regarding everything from your different sources of revenue to an explanation of your COGS and operating expenses. Factors like rev rec compliance and proof of cash are often included in this section to further expand the insights a buyer can gather.

The Balance Sheet section employs a similar tactic, providing in-depth information that a reader might miss in your audited financials, including everything from intangible assets like intellectual property to common holdings like real estate. Both the Income Statement and Balance Sheet sections should include adjusted figures with thorough explanations for any stated adjustments from the audited financials. Granted, this could work for or against you depending on the nature of the adjustments, but certainly helps clarify the overall picture. Remember that nearly any adjustment that negatively impacts key metrics like your margins, for instance, would turn up in the buyer’s due diligence anyway.

Supplemental Analysis

A Supplemental Analysis section is another opportunity to thoroughly explain your operations, emphasize any particularly insightful metrics, and distinguish yourself from other market participants. A Key Customer Matrix, for example, might demonstrate a well-balanced customer base that doesn’t rely on any particular customer for the majority of your revenue, thus mitigating risk for your company.

Similarly, a Revenue Bridge Analysis lets you breakdown the changes in revenue between periods for existing, new, and lost customers. These types of illustrations are uniquely capable of providing granular data points that aren’t readily available in the standard set of financials. Along with the other sections of a due diligence report, these supplemental illustrations paint a fuller picture of your business and operations for a buyer or investor.

Other Best Practices

Between the accompanying seller’s checklist to help prepare an insightful report for buyers as well as our insights on particular topics, you already have a head start in catching the stare of the hyper-selective M&A market. However, we thought it best to give you a few more best practices to keep in mind as you proceed.

Download: sell-side due diligence report checklist

Have Your Ducks in a Row

Financial transactions are both complex and time-consuming. An investment group will always have experts at the ready to look through every aspect of your company and operations with a mammoth-sized magnifying glass. Therefore, along with our accompanying checklist to prepare your report for buyers, it only makes sense to bring in outside experts for further guidance. With that far-reaching guidance as a compass, go through your contracts, books, records, and anything else that will play a role in the transaction’s ultimate success. Also, an experienced partner will identify particular points that a buyer will focus on, helping you to prepare in advance and increase the chances of a purchase price that makes everyone happy.

Get Organized

Any buyer will likely have an extensive list of document requests and questions for you once their due diligence begins. In anticipation of this inevitability, go through all of your documentation to make sure you have quick access to the most current versions of your documents, complete with all necessary signatures, attachments, and schedules. Being well-organized ahead of time can save you a good deal of frustration down the road.

Delegate Responsibility

Once you decide to sell your company or attract investment capital, there’s much work to be done and usually not enough time to do it. Streamline the process by delegating particular responsibilities and tasks to individuals or teams within your organization. A clear and concise workflow chart that’s accessible to every employee involved in the process will maximize efficiency and impact along the way. Remember, you still have a business to run during a sale, and there’s only so much time and resources to go around.

Be Descriptive With File Names

This tip is a bit on the granular side, but you’ll thank us once your sell-side diligence begins. As we said, a buyer is going to request a mountain of documentation from you, meaning the faster you provide them exactly what they need, the quicker you can reach an agreement. Part of your pre-sale organization efforts should include adopting a system of highly descriptive file names and reference numbers so you can quickly locate any file needed by its filename and avoid having to read through 250 documents to find the right one.

Customer Confidentiality

Although you obviously want to put your best foot forward when finding a financial suitor and dazzle them with sparkling sales metrics, never forget the privacy agreements you have with your existing customer base. As you organize, prepare, and distribute documents to potential buyers, redact names and information when appropriate to avoid violating those privacy agreements. This is especially important at the beginning of the process when everything is still a bit up in the air on the sales front. It goes without saying that your customer base is one of your most valuable assets and something you must sufficiently protect, especially during a sale.

Retain Your Data for Future Use

Deals fall through all the time, often for no obvious reasons. As you wade into the due diligence waters and prepare information for a prospective buyer, keep all of that data handy in case things go sideways. That way, you have everything ready to go for the next buyer and won’t have to reinvent the due diligence wheel with each possible sale. That meticulous documentation can also be a lifesaver if a deal does go through and issues arise after the fact, allowing you to quickly find any information provided throughout the process.

Embark understands that it might seem like sellers are living in a distinctly buyer’s world. That’s exactly why we provided our checklist and these best practices -- to give sellers valuable information that isn’t easy to come by elsewhere. Whether you use our due diligence checklist as a means of early preparation for an eventual sale or investment, or as a window into the sort of items every buyer will look through, we’re certain you’ll find it uniquely insightful and beneficial to the process.

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Of course, given the importance of the sale process on the future of your enterprise, employees, and even customers, an upcoming transaction is no time to leave any financial stone unturned. While our checklist goes an awfully long way in helping your preparation, the due diligence report it drives is really what gets the closing ball rolling. Embark’s team of financial gurus can take the data you’ve assembled with our checklist and craft a seller’s report that shines the best possible light on your organization, anticipating buy-side needs, and significantly increasing the chances of a purchase price that leaves you with a smile on your face.

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