Private Equity Experience

Due Diligence: The Key to Unlocking Your Company's Value

• Emily Sander • Season 1 • Episode 6

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In this episode of the Private Equity Experience podcast, Ed and Rory dive into due diligence, a crucial step in buying or selling a business. They explain what due diligence is, how it works, and why it's essential for determining a company's valuation. The hosts also discuss the importance of working with experienced professionals, such as investment banks and financial advisors, to navigate the due diligence process and ensure a successful transaction. Learn the importance of due diligence in buying or selling a business and how to navigate the process with experienced professionals. Get tips and resources for finding reputable investment banks and financial advisors.


Show Notes:

  • What is due diligence, and how does it fit into buying or selling a business?
  • The importance of due diligence in determining a company's valuation
  • How to conduct due diligence on potential partners or buyers
  • The role of investment banks and financial advisors in the due diligence process
  • Tips for working with experienced professionals to navigate the due diligence process
  • Resources for finding reputable investment banks and financial advisors


01:14 Understanding the Due Diligence Process
07:14 Costs and Challenges of Due Diligence
09:08 Green Flags and Red Flags
22:34 Common Pitfalls and How to Avoid Them
28:02 Preparing for Due Diligence

Who We Are

If we haven’t met before—Hi! We’re a team of professionals who’ve worked together at multiple companies, seen private equity from all sides, and are here to share what we’ve learned to help you succeed. Ed Barton brings decades of tax and financial strategy experience; Rory Liebhart is a finance and M&A pro with a track record of high-growth exits; and Emily Sander is a former Chief of Staff, multi-time author, podcast host, and founder of Next Level Coaching, helping leaders and organizations accelerate their growth.


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Connect with Emily

Connect with Rory

emily-sander_1_12-10-2024_160253:

Ed Rory, dilly, dilly, due diligence,

ed-barton_1_12-10-2024_160249:

dilly.

emily-sander_1_12-10-2024_160253:

dilly, dilly,

ed-barton_1_12-10-2024_160249:

dilly.

emily-sander_1_12-10-2024_160253:

due diligence. What is this and where does it fit into the process?

squadcaster-adea_1_12-10-2024_160251:

in business or in life. Cause it could be applicable in so many

emily-sander_1_12-10-2024_160253:

How do you conduct due diligence on potential partners? No, we're talking about business. Let's do, well, I guess that could be used for both business and personal. It's all the same. Do you create spreadsheets and virtual data rooms for your potential?

ed-barton_1_12-10-2024_160249:

Dilly dilly.

emily-sander_1_12-10-2024_160253:

You probably do actually

ed-barton_1_12-10-2024_160249:

Dilly

emily-sander_1_12-10-2024_160253:

you, you, you think in spreadsheets. Um, no. So we're talking about due diligence. When someone is looking to buy your company, they are going to conduct due diligence as would make sense. If you are going to invest millions and millions of dollars in a company, you want to know what's going on. What's up? And so due diligence is the official process and way of figuring out what's up with this company.

squadcaster-adea_1_12-10-2024_160251:

the heart of it. Um, due diligence is really, it is a deep investigation into the information supporting a decision, a transaction. you know, uh, you know, uh, uh, an action that you're looking to take. So at the heart of it, you're just doing investigative work on a potential outcome you're trying to consider basically.

emily-sander_1_12-10-2024_160253:

Are, are P. E.?

ed-barton_1_12-10-2024_160249:

due diligence, was going to say the due diligence process is the driver for your valuation, all things being equal. you know, you've got a business and what that process does is basically you've said, my business does all these wonderful things and it's got these capabilities and. You know, we're the best, you know, shoe manufacturer in the United States and you need to buy us. And due diligence is really the confirmation of all the things you're claiming. And so it's, it's a very, it can be a very, very, very deep dive.

squadcaster-adea_1_12-10-2024_160251:

And I mean, it covers various things under the umbrella of due diligence. I mean, you have financial due diligence, you have legal due diligence, you have operational due diligence, you have due diligence, I mean, everything that goes into. A business that comes under scrutiny during a time of, let's say or M& A or, or, or sort of a transaction that's all wrapped up in this concept of due diligence, you're really, you know, deep diving on the business entirely, as Ed said, um, in, you know, oftentimes a very compressed amount of time. So it becomes a very critical and oftentimes stressful part of that deal framework.

emily-sander_1_12-10-2024_160253:

Yes, and so are they, would you say they're trying to find things quote unquote wrong with it, or they're trying, I mean, we use the analogy of like buying a house, and so when someone goes in for inspection, they're They're looking for things to like, let me pay less. Are they looking for that? Are they looking for no confirmatory evidence that we want to buy this thing or just tell us what's going on under the hood so we can make adjustments and then decide to move forward and have a plan from there.

ed-barton_1_12-10-2024_160249:

All of the above? Truly, it is truly all the above. Really, really, I've generally said you've got a couple of phases of due diligence. there's a, there's a, there's going to be first phase or preliminary due diligence where they're really trying to get a feel for the business, the operations, the, how you do things, the, management team, they're not digging deep, but they, they're digging broad and going, okay, do we really feel like we've got a good understanding of this? and that's normally done if you're, if you're in a transaction, that's normally done, um, kind of after the first set of meetings. There's the lobe and parts of the data room and kind of let, let the potential buyers go in before they submit their letter of intent or indication of interest. then there's, once you kind of get through that, on their side, on the private equity purchasers side, they've come up with that thesis, investment thesis. This is what we think the investment can do. This is what we expect to be able to get for efficiencies. This is what we can do from a capital perspective for, you know, balance sheet engineering. And then. You go to the next phase of diligence, which is confirmatory diligence, which is a going now, we want to confirm all the assumptions that we've put in there and we want to make sure that there's no surprises. Now, everybody knows there's always going to be surprises, but the fewer surprises, the better. And the more you can cooperate and disclose, you know, we talk about finance theory in, in, in this pod. So the, the you can disclose, the lower the risk premium, which means a higher. The higher the value of the business. So I, so that, but that those two phases of diligence are important because they're looking at very different things. One is coming up with a thesis, understanding the business before they put an indication of interest or LOI in. And then the second is really to confirm all those assumptions and try and make sure that there's no surprises.

emily-sander_1_12-10-2024_160253:

Yeah. So the first one is kind of like a surface level. Like, let me just sniff around and get, get a lay of the land. And then the second one, I've heard someone on this podcast described as like a anal probe where it's like, okay, we're doing a full look at the inside of this business. Yes.

ed-barton_1_12-10-2024_160249:

exam. The, the, the, the other piece is for founders and management teams to recognize is diligence starts at the time you sign up the investment banker. So the investment banker is going to do diligence on you to make sure you're ready. A lot of times they're on a contingency fee, so they don't want to burn cycles, um, without feeling like you've got a transactable business. And then after that, when you've got prospective buyers, diligence starts with their first teaser and your first conversation. They're going, okay, is this somebody who I can partner with? How does he make, how do they make me feel? Are they smart? Me? Do I feel like this is, you know, they're trying to hide something. So diligence starts at preliminary diligence or, or kind of initial diligence phase starts the minute you decide to start putting your business on the, on the market. And doesn't end until after the deal closes.

squadcaster-adea_1_12-10-2024_160251:

Every piece of information that is shared between parties is subject to scrutiny, um, you know, challenge, um, validation and, and that's what comprises due diligence. And what I would say as well is, you know, Due diligence is a very costly process for all involved and we can get into You know the the throws of it, but basically, you know I've been part of deals where I know for a fact that the other side the potential acquiring party is spending millions of dollars to Validate this as a potential transaction. So while I agree with ed's broad statement that they're looking for, you know Validation either way i'd say most parties get to this phase of deep diligence With the intent that they can move forward with the deal there. They're, you know, they don't want to spend millions of dollars for nothing. There's something in the game skin wise for all parties at a certain point, but upfront, yeah, I think, that's why the due diligence process is done. As I'd said, in a phased manner, typically. What I've observed is that, you know, the customer due diligence, the market due diligence, the, the, the, the things that underpin the business, your business model is kind of what's pushed up front so that that can be validated first, followed by financial due diligence. And then lastly, which gets to be kind of the most expensive piece of it is the legal due diligence. All of the stuff involved with that, um, you know, regulatory due diligence, compliance due diligence, that's stuff that need to validate, but if you can't get past the business diligence, um, and the financial diligence, you're, there's no point in spending the money and energy on all the other supplementary pieces of that. Very

emily-sander_1_12-10-2024_160253:

Okay. So this process. The later stages of it are very thorough. I'm going to use that word, but this is also critical to determining the valuation. So if you're a founder, you want to pay attention and be ready for this, which is part of why you listen to this podcast. So we can kind of tell you what's coming your way,

squadcaster-adea_1_12-10-2024_160251:

hmm.

emily-sander_1_12-10-2024_160253:

but how, how does this process work? Like who on the PE team are you going to be dealing with? What are green flags? What are red flags? Just how does this process work? If you're like a first time founder going through due diligence.

squadcaster-adea_1_12-10-2024_160251:

yeah, exactly right. And I think you kind of touched on it there. Green flags, red flags. I think, you know, red flags are the things that people really, uh, you know, kind of expect to find in some ways. Just every business has its own little, little skeletons in the closet. It seems, you know, things like that. But the point is to get your arms around that doesn't mean just because those exist, that there's not a deal to be done.

emily-sander_1_12-10-2024_160253:

Right.

squadcaster-adea_1_12-10-2024_160251:

them and you understand the implications, Yeah, yeah. usually get past these things, but it's those green flags that are interesting. I mean, I was just having a separate conversation with Ed about a deal he was involved with where, you know, I know Ed was doing deep diligence and found some opportunities and then closed the deal. And it turns out those opportunities are green flags and there's going to be a better deal, uh, than what he paid for prospectively, you know, so those are things that can happen, that's only a result of the thorough work being done on the buying party. And then the heavy work doing on the party that's selling and getting the information put together in a way that can be digested and relied upon and ultimately trusted at the end of the day.

ed-barton_1_12-10-2024_160249:

the one thing to keep in mind, I think if you're a founding management team and you haven't been through this before, is be prepared to be overwhelmed. the reason I say that is when the diligence starts, you're going to have, it's going to be a couple of private equity folks, you'll have an associate, a principal, or a VP level, a director, a managing director. So it'll be three or four folks that will be playing from the private equity side. Once you move to the confirmatory. As Rory noted, you know, the last deal where I was on sell side, the buyer probably spent 22 to 25 percent of the purchase price on diligence.

squadcaster-adea_1_12-10-2024_160251:

Yeah.

ed-barton_1_12-10-2024_160249:

so it was a 20 million deal. They may have spent 5 million on diligence. So it was, it was a ridiculous, uh, it was ridiculous for my seat as a seller, ridiculous diligence.

squadcaster-adea_1_12-10-2024_160251:

Yeah.

ed-barton_1_12-10-2024_160249:

but you had, you had not only did you have the private equity folks, You had their operating partners were involved in their various areas. So you had folks basically who were kind of the acquiring company, CFO, the acquiring company. So it was private equity backed. A merger with one of their other portfolio companies, so you have their operating partners in. They had IT consultants come in to look at the systems and determine what technical debt needed to be retired or what we should do with our stack. They had accounting folks come in, including forensic type accountants to be able to go back through our, all of our, um, transactions over the last couple of years and determine because we had non operating losses whether it was, you know, more beneficial to, to acquire the operating entity. Um, or to acquire the assets. They had, um, legal due diligence, include two different law firms, one for intellectual property and another one for transaction. Um, so it was, and, and it was just, you know, there was just like four of us on the management side trying to juggle all that stuff.

squadcaster-adea_1_12-10-2024_160251:

Yeah,

ed-barton_1_12-10-2024_160249:

and you had another consulting firm coming in to validate the market analysis, um, that we had provided for a couple of our products. So it was, it was, oh, it was overwhelming as on the sell side and just be prepared to All of a sudden have an army of consultants, accountants, lawyers, scientists and everybody else descend upon you and be requesting tons of information. And on the flip side of that, lean on the investment bank to help you prioritize, manage that workflow and set expectations with the, with the buyer. Um, it's, it's, that's part of their job.

emily-sander_1_12-10-2024_160253:

And I think, I mean, this is all happening while you're doing your day job. And so part of the prep is setting it up so you can lift out hopefully and someone can maybe take point or just know that, Hey, I'm not going to be as responsive or set up processes. Um, how long does diligence typically take if there's a typically, what is the, like, what are we talking weeks, months, years, let's give people a broad brush here.

squadcaster-adea_1_12-10-2024_160251:

I put it on three to six months typically,

ed-barton_1_12-10-2024_160249:

Mm hmm.

squadcaster-adea_1_12-10-2024_160251:

you know, and it could be anywhere in between, um, depends on the complexity of the deal. Depends on how simple your business is, you know, how, what industry you're in as far as, you know, call it regulatory hurdles go and things like that. Um, you know, it depends on deep your cap table is. There's a lot of things that could go into. know, whether you, you know, what, what hoops need to be jumped through for you to actually sell your, your business or the equity in your business or the assets of your business, et cetera. So there's really can run the gamut. Um, you know, as your business international focus, or is it domestic? The services based industry manufacturing, totally different, totally different, um, tracks in that way. But it does come down to kind of investigating. same sorts of things just keep coming back to the financials, the market, the product, the, the legal, the compliance, the operation, but it just has different levels of complexity. I mean, in a service oriented business where you don't really have a physical workspace and you know, it's not capital intensive in terms of, you know, CapEx, then, you know, a lot of that can be done pretty remotely, but if you're, you know, buying a. You know, um, oil, well, you know, manufacturer, I mean, that's pretty on the ground,

emily-sander_1_12-10-2024_160253:

Got to go inspect the oil well, yeah,

squadcaster-adea_1_12-10-2024_160251:

the dirt and see if it can be fracked up or whatever the hell, you know, it's like there's actual tangible things you need to touch in certain businesses. Whereas I've personally worked for mostly services based businesses where it's. Pretty light on that kind of stuff, but you know, it can be pretty intensive if it's a, know, a, a, a, a business that involves a lot of people and a lot of locations and a lot of, uh, know, terra firma, let's say. Yeah.

emily-sander_1_12-10-2024_160253:

that's a good point. And I think

ed-barton_1_12-10-2024_160249:

I was going to

emily-sander_1_12-10-2024_160253:

the other thing I was just going to.

ed-barton_1_12-10-2024_160249:

is, is you're running in parallel to the diligence, the confirmatory diligence, you're generally running the process to put the, um, final agreements together, so the asset purchase agreement, uh, or whatever format that agreement is gonna, is gonna come in.

squadcaster-adea_1_12-10-2024_160251:

Yeah.

ed-barton_1_12-10-2024_160249:

they find in diligence then starts another cycle through the agreement, because they go, Oh, we've identified something we want to, We want to have a rep and warranty on that. Or we want to have an indemnification against that. Or we want to retrade the deal or we're going to have an additional, you know, a additional, like the, the, these deals are like three inches thick and they've got a bunch of disclosures and I go, Oh, we're going to need to disclose this. And so anytime

squadcaster-adea_1_12-10-2024_160251:

attorneys are paid by the red line keystroke. You know what I mean? Like some of these

ed-barton_1_12-10-2024_160249:

we, we do, we do endeavor, we do endeavor to, to make sure that the billable hours requirement is met.

emily-sander_1_12-10-2024_160253:

You're being thorough. You're being very thorough. Yes.

ed-barton_1_12-10-2024_160249:

where you're going to end up with a,

squadcaster-adea_1_12-10-2024_160251:

Yeah.

ed-barton_1_12-10-2024_160249:

does that entire, you're running multiple work streams and a diligence piece. You may, you're going to have financial diligence, the tech diligence, you know, risk diligence with insurance, all those things are running parallel to the legal drafting of the documents and anything that comes up in any of those parallel work streams dumps into the legal drafting of the documents generally and will impact the deal. So. then they go and iterate

emily-sander_1_12-10-2024_160253:

It's a cyclical.

ed-barton_1_12-10-2024_160249:

Why don't you look deeper at that?

squadcaster-adea_1_12-10-2024_160251:

Yeah.

emily-sander_1_12-10-2024_160253:

and then how often are you running multiple due diligence processes at once? Like, could you be doing that?

ed-barton_1_12-10-2024_160249:

not have, I was about to say during the

squadcaster-adea_1_12-10-2024_160251:

Yeah.

ed-barton_1_12-10-2024_160249:

the kind of, we're out in, we're out in market. Um, we don't have indication of interest LOI. You may have four or five looking at you at the same time. Always. similar, um, but somewhat different, um, asks.

emily-sander_1_12-10-2024_160253:

What about confirmatory diligence?

ed-barton_1_12-10-2024_160249:

a confirmatory, you're normally running one.

emily-sander_1_12-10-2024_160253:

One at a time.

ed-barton_1_12-10-2024_160249:

my experience is we normally have, you know, we pick, we we go through the beauty contest to get the indications of interest or letters of intent. You go, okay, This one's the prettiest. I'm going to go out with her or him and then that becomes the one you're doing confirmatory on. And if, because again, as Rory noted, it's millions, hundreds of thousands to millions of dollars. And so both the person who's doing the diligence and the company want to do, you know, they're not going to spin up those cycles if they don't think they're going to win the deal. So you're generally going to have one at that point. Oh,

emily-sander_1_12-10-2024_160253:

And then,

squadcaster-adea_1_12-10-2024_160251:

of some interesting ones actually. I mean, know, in the last, uh, Last stop I was at prior to kind of stepping out and doing some consulting work, you know, I was in an interesting position where my company was bought and there was a diligence process associated with that, subsequently carved out and sold and there's a diligence process with that all in basically this, this sort of, you know, continuous cycle of like 18 months of diligence work. To do a couple of different transactions. So, and I, you know, I've been, you know, kind of party to some other situations too, where, know, uh, you know, uh, a company's being acquired and then immediately they're going to go out and buy another business, right? Like, so there's just, know, you get to a certain point of sophistication. These PE groups are extremely sophisticated and this is what they do, where they have these as just part of their core business. So where to, but to Ed's point earlier, and what we talked about with. Being on the, um, sort of side of a founder or a company selling, you know, for the first time or something like that. It is absolutely new territory and it can be really stressful in the business, especially if a deal deal doesn't actually get done. So you go through all this process only to basically have a deal

emily-sander_1_12-10-2024_160253:

Ed looks sick. Ed looks physically sick.

squadcaster-adea_1_12-10-2024_160251:

yeah. And I mean, that just, it, it's a, it really takes a toll. So, you know, it comes back to what we've covered in our book and our prior podcasts is like, be really clear on what your objectives are to sell, you know, what your, um, you know, what, what, what, what pieces of that can you. coordinate for and plan for get all your team in place before you actually pull the trigger on the process. Cause a dead process is really deleterious to, know, your business and your life, you know, like you may have, you may have been spending that money before you got it. You know what I mean? Like that's

emily-sander_1_12-10-2024_160253:

That never happens with founders. Come on Rory.

ed-barton_1_12-10-2024_160249:

and recognize, recognize what,

squadcaster-adea_1_12-10-2024_160251:

later on, you

ed-barton_1_12-10-2024_160249:

recognize what Rory just said, which is, um, you know, it's, it's incredibly stressful. Recognize that diligence is running in parallel and you don't want the, the process to be a failed process. So some of your more cutthroat, um, private equity firms will give you a very attractive letter of intent, indication of interest. Um, run you into diligence and then retread the deal a couple times.

emily-sander_1_12-10-2024_160253:

oh

ed-barton_1_12-10-2024_160249:

because you're like, Oh,

squadcaster-adea_1_12-10-2024_160251:

on this call might have done Yeah, yeah,

ed-barton_1_12-10-2024_160249:

you just don't, you're like, I just, I,

squadcaster-adea_1_12-10-2024_160251:

yeah

ed-barton_1_12-10-2024_160249:

like six months and I've just got to be done. And they go, well, you know, we're going to have to knock off 10 percent of the purchase price because you know, we've identified this, that, and the other thing. So that's where the investment bank is important because they've generally dealt with the private equity folks before they want to get a deal done. You know, you can get some insight both from the, from the investment bankers as well as, you know, just kind of asking around what's reputation of this investment of the private equity firm or growth capital firm that you're talking to. And do they have a tendency to retrade deals? Cause if they do, just be prepared for it and go into diligence accordingly

emily-sander_1_12-10-2024_160253:

Well, and I mean some PE firms like there's different personalities and approaches but some people know that people get worn out It's like oh my gosh, like all this sunk cost has been six months I'm, so tired just drag this thing across the finish line And some people know that and they're just they'll play that game and some people are like no I actually need to know this information to feel comfortable You Giving you this funding.

ed-barton_1_12-10-2024_160249:

buy a new car.

emily-sander_1_12-10-2024_160253:

Yeah.

ed-barton_1_12-10-2024_160249:

they'll just wear you down until you

emily-sander_1_12-10-2024_160253:

Oh, I hate that. Gosh. I, oh,

ed-barton_1_12-10-2024_160249:

Well, it works.

squadcaster-adea_1_12-10-2024_160251:

say this though, like, I think that, you know, I think stats out there would indicate, you know, the average PE firm looks at probably, you know, call it 30 to 50 deals a year, maybe do one or two. So, you know, um, once they do kind of get committed to a deal, they do want to see it through ultimately, because it's, again, it's a waste of their time and skill. It's both tangible costs that sunk, but it's also opportunity costs that sunk if you spend more time than you need to on a deal. So, I think that overall there's an inherent level of tension on both sides that once you get to a certain point, you both do want to see the finish line. Because if they start to really believe in your business and believe, especially in the management team running the business, like, You know, they're, they're seeing the dollar signs and that's what they're, that's what they're built to do is to deploy capital and make money. So you do have a inherent alignment I think, but yeah, deals fall apart. I've been part of those and it's, it sucks, but you know, that's just how it goes sometimes.

emily-sander_1_12-10-2024_160253:

okay. So we've got this three to six month long process. It's very thorough, but if you're prepared, it can go relatively smoothly. If you know what you're getting into, um, as Faye says, no, it's always just going to be kind of a slog. Um, let's talk about, Actually, let's talk about first how this can go bad, how this can go badly, and then talk about how to make it go smoothly in good case scenarios. So I have an example where, um, something big was missed during due diligence, and it was regarding a tech stack. And one of the things, one of the things to note is, um, The level of due diligence, Rory was mentioning all the different factors that go into the level and level of effort of due diligence. One is how the investor is going to use that company. So for instance, we work for a data company and some potential buyers just wanted our data. So they, if they were to have bought us, they would have gutted the thing and just taken the data. And that's what they wanted. Other people might want like your, Customers and your tech stack and your people and so those might be things they, uh, look at thoroughly. So in this one instance, there was, I don't know, like an oversight or people weren't, um, looking hard enough or people were being creative with how they presented things, but the tech stack was not. Thoroughly investigated and that came back to bite us hard later on and so um ed Do you want to talk through? like what happens when when those things take place like Clawbacks or clot is in place at the beginning to kind of help prevent or mitigate those things

ed-barton_1_12-10-2024_160249:

Yeah. So there's a couple of different ways that, uh, those can be mitigated. The first, the first is you've got a, um, an escrow, essentially, so the, so the deal, you're going through the deal process and something comes up and you're like, you know, Oh crap, we've got to, you know, again, it comes up during diligence. So you talked about something that was missed. If it comes up during diligence, it's likely to get addressed either in terms of a re trade. Disclosure or, uh, an indemnification or a rep and warrant. If it doesn't get, if you rep and warrant all this stuff, like my tech stack is great and everything's super and blah, blah, blah, blah, blah. And then it got missed. you're likely to get into, you know, what the technical term is a pissing contest with the, as a seller, um, with the buyer post sale. Um, and there's generally this concept of an escrow where they go, look, we're going to buy the company, let's say for a hundred million, but we're going to hold 10 million back and we're going to true up any non collectible receivables or any claims that we have that are larger than a de minimis amount. That de minimis amount

emily-sander_1_12-10-2024_160253:

Is this like the security deposit on an apartment?

ed-barton_1_12-10-2024_160249:

It kind of is. And they've got this thing called a basket where they may go, you know, it's got to exceed 500, 000. And if it does, and we'll start dealing with it because they know it's going to be a little bit of a urination contest between, you know, I agree, I don't agree. Um, in the case of that, uh, that you're talking about, which I was involved in. There was no rep and warrant on the tech stack. Um, the, and it had brought in a third party consultant. Um, and so as a result, the issue was then between a private equity firm and a third party consultant, not between the private equity firm and the seller.

emily-sander_1_12-10-2024_160253:

Ah

ed-barton_1_12-10-2024_160249:

repped, repped or warranted as far as that. So it then fell to the portfolio company, IEU and I, and several others to get that fixed you know, what would have been a, no, this is all good and everything's great. And here's the SOC report and all the other good stuff on the tech stack. And then it fails, then it could be on the seller.

emily-sander_1_12-10-2024_160253:

what happens ed or rory if i'm going to say hypothetically but we may or may not have been involved in this too where a founder would Intentionally steer the due diligence folks away from certain information or just flat out lie. Like what if someone hypothetically just like flat out lies about the state of their tech or company or whatever.

squadcaster-adea_1_12-10-2024_160251:

That's a, that's a, that's not a good method to take. Um, uh, I think that on the extreme side, you know, it could lead to downstream litigation and, you know, other punitive ways of compensating for those lies and omissions. Um, At the very least, it erodes trust completely, um, I'd say. And trust is such a big part of business and life. And especially in these deals where you're talking about large sums of money. So, um, it happens though. Um, I think some people. Have a hard time walking that blurred line between, know, overselling your business with maybe not evil intentions versus out and out lying. I do think that some of those things happen without ill intent, rather just saying, Hey, I'm, I'm highlighting the good, right? So, but what happens, you know, many things could happen, not the least of which is. a deal falling apart or, you know, a purchase price being reduced, um, to account for whatever that is, plus some punitive retrade because, um, you know, and then we're, we'll certainly travel about that business and that. Founder or whomever it is, know, you might have a real hard time marketing your business or yourself as part of that business in the future if you take that tax, so definitely not wise.

emily-sander_1_12-10-2024_160253:

Okay, any other warning stories or just hey, here's how to make this process

squadcaster-adea_1_12-10-2024_160251:

Yeah,

emily-sander_1_12-10-2024_160253:

as less, you know, as painless as possible.

squadcaster-adea_1_12-10-2024_160251:

yeah, I'd like to say it always starts kind of before you go down the path. And I think what I like to call good corporate hygiene is something to focus on, you know, you know, you're going to be sharing deep information with qualified parties. So make sure the information you end up sharing is. really well organized, tells the right story in a truthful way. Um, and you know, you, you, you don't leave any stone really unturned because time can kill deals. So the faster you move through your diligence process, the more likely are to get a good deal done. Um, let alone at the purchase price that may have been coming through at the letter of intent level, which is always kind of a headline price. Um, so just prepare ahead of you, if you can, I like to suggest that companies set up a data room well in advance, populate that thing and continue to evolve it as information becomes more, um, updated. So as you grow your client base, as you add new contracts, as your financials evolve, just have a habit of keeping a data room populated. So when the time comes, you're not scrambling to put it all together in short order, probably missing some things, um, not giving, Proper level of scrutiny to it. And then just start off on the right foot, you know, um, make it easy for the suitors to look at your information and have conversation with you about it. You know, make disclosures, uh, you know, that are reasonable. So people like they're going to find things regardless. Um, and we talked about that in the book, so you might as well get it out there in the, in the, the way that makes sense. Um, know, if there's questions about some of the things in your business

emily-sander_1_12-10-2024_160253:

What are, what are some of the core pieces that you can and should put in that data room knowing that you don't know the buyer yet, you don't know the exact type of diligence that's going to be conducted, but they're always going to want to know about these things.

ed-barton_1_12-10-2024_160249:

Well, I was going to say there, there's a few things that, uh, you know, start, start with the, what would you want to know?

squadcaster-adea_1_12-10-2024_160251:

Yes. Great.

ed-barton_1_12-10-2024_160249:

So, so, you know, if you were going out to buy this business, what would you want to know?

emily-sander_1_12-10-2024_160253:

Yeah.

ed-barton_1_12-10-2024_160249:

the second thing you need to put in there is what don't they know that if they find out is going to blow this deal up and put it in there, because if you don't, they will find it. And that's the fastest way. So, you know, most of the deals that I've seen between private equity and founders, they end up going sideways at some point. Now, sometimes they pull it back together and other times it goes off the rails and then you got to change and then you get changed out as a founder. And that can be, you know, obviously a very distressing experience. The fastest way to get yourself fired from your own company, if it's private equity sold, is to not be forthcoming in diligence. And because now you've destroyed the trust that you theoretically were supposed to be building over the course of that diligence period. That's something that they are looking for. Is this, is this management team, a management team we can trust, that we can work with? We're about to invest tens of millions or hundreds of millions of dollars of our limited partner's capital. Can we trust these folks to be good stewards of that capital? And so, number one is put anything in there that you would want to know. So, financial statements.

squadcaster-adea_1_12-10-2024_160251:

Yep.

ed-barton_1_12-10-2024_160249:

any, you know, disclosures around lawsuits or, you know, and people issues and any of those things that are, you know, some risk factors and opportunities as well. So it's not all negative, but, um, and then anything that, if it's going to blow the deal up, if it gets found out later, get it out on the table. Actually, you should be talking to the investment banker about that before the deal goes to market on how best to position it because they can use it as a buy, as a buying opportunity. So our tech stack is terrible. Okay, fine. This is a great opportunity to find a strategic buyer or a private equity firm that may have somebody in their portfolio where that becomes a competitive advantage to them in the deal space. And then the, the investment bank can position you in a way that, you know, they turn a negative into a positive or at least a neutral

squadcaster-adea_1_12-10-2024_160251:

Yep. Exactly.

emily-sander_1_12-10-2024_160253:

And I think a good guideline for people is just, they will find everything. It's just a matter of when. And so like you need to be strategic about when you disclose that because they will find. Everything. And so you want that to be all up front and like Ed and Rory were just mentioning, you might think this is the worst thing in the world. Like, Oh, Oh shit. Like this, I can't tell them this. They might go, Oh, I can flip that into an advantage or like, Oh, we've seen that before. That's not that bad. That's just an opportunity we can have to create an efficiency.

squadcaster-adea_1_12-10-2024_160251:

Information is power both ways in a way. Like you, you, you share more information to help them understand your business more. It's possible that in their initial look at your business, they're missing some opportunities that you might be able to articulate with what you share. Yeah. You couple that with having multiple players at the table that have maybe, you know, slightly different, uh, perspectives on what they want to do with your business. Once they acquire it, could turn into higher valuation for you. Again, don't hold back because, know, you know, you get a diligence request list and it only has certain things on it. If you have things that accentuate your business in a favorable yet truthful way, that is the quickest way to convince somebody that they, need to pay higher value for your business if you can articulate with data and information for sure rather than just pure anecdote for sure

emily-sander_1_12-10-2024_160253:

Yeah. And I think what we're talking about here is the best way to increase the valuation of the company, which is through this process, which is thorough and can be like overwhelming. Sometimes it is just having these conversations and establishing this foundation of trust where just these layers and these different stories that you're able to tell. And you have these conversations like, yep, we did this by duct tape and yarn because that's what we had. And so this is what it is today. Yeah. Given funding, we can make this better. So I think telling those stories all throughout the process and just developing that rapport is, is where it goes well,

ed-barton_1_12-10-2024_160249:

hmm.

emily-sander_1_12-10-2024_160253:

anything else either of you would add of, you know, here's a smooth due diligence process, or here's how you really optimize this process.

ed-barton_1_12-10-2024_160249:

I think one of the biggest, one of the biggest things is, and we talked about this in one of the prior episodes, is have your team assembled ahead. Work with the investment banker. They've been through, they do this for a living, right? So you can work through, um, the, they'll talk you through, walk you through what's going to get looked at, where the major issues are. Treat them as kind of your trusted advisor, because they are, they need to be. And it all out there and help them. Help them understand your business better so they can help you position the business better and get you through diligence. I can't, um, I can't stress enough that having that team put together, your attorneys, your accountants, your, and most of all, your investment banker in this particular case, and a good one who's been through these things before, will be able to help you lay out all of that and prep you, uh, for diligence so that your data room's ready, you're, you've been kind of wired with questions and answers. Um, and they know who the buying universe is and they're going to put you in a good position to win.

squadcaster-adea_1_12-10-2024_160251:

Work with people that have done it a lot, you know Um, even if you don't have that resource on staff there are a lot of out there consultants that have done this many times and that you know could be minimally invasive to your core business without you know, disrupting other people doing their core business. If you're in the early stages or you haven't really like full on went, went full speed ahead. So, you know, just like you have lawyers and accountants and so forth as kind of external, you know, consultancy work with, or parties you work with, know, folks that have worked in Corp dev and, you know, run businesses that have been acquired, bought and sold, you know, they can add a lot of value on a fractional or consultancy basis.

emily-sander_1_12-10-2024_160253:

Yeah, and I think just know that as a founder, you're a genius in what you do. Like you've built this company and it's okay if you don't know how to do these other things, but other people are experts, experts in these areas. And so you want to partner with them and assemble a team so they can help you in those ways. And if you're like, Again, if you're like, I don't know investment bank from like my ATM machine or whatnot, we have resources that can help you. So we'll drop those in the show notes for a list of reputable investment banks and different financial advisors that you can work with. And you can always check out our new resources at private equity experience. com. But now, you know about due diligence, a very important part of the process. So thanks, Ed. Thanks, Rory. Catch you next time.

squadcaster-adea_1_12-10-2024_160251:

Thank you.

ed-barton_1_12-10-2024_160249:

Thank you.