In 2011, HP made headlines with its ambitious $11.1 billion acquisition of the British software company Autonomy. The deal promised to transform HP’s presence in the software and data analytics industry. But within a year, HP faced an $8.8 billion write-down, alleging that Autonomy’s financial records had misrepresented revenue and growth, leading to a valuation built on shaky foundations. HP claimed that hidden accounting improprieties—such as misclassified hardware sales—had gone undetected in due diligence, unraveling the deal and sparking costly litigation that continued for years.
What if Autonomy’s leadership had proactively identified these issues and disclosed them to HP before the acquisition? Could a different approach to due diligence have prevented this disaster?
The seller due diligence isn’t just about transparency; it’s about understanding and mitigating risks that could derail a deal.
Why does Seller Due Diligence Matter in M&A?
Before submitting a formal offer, a buyer typically conducts an initial appraisal of the commercial and financial aspects of the business. The buyer’s detailed due diligence only begins once the terms are tentatively agreed upon. This final, thorough review allows the buyer to verify their assumptions, assess business risks, and refine post-acquisition integration plans. Consequently, it’s essential to have a seller due diligence to be proactive in preparing, as this can accelerate the sales process and help maintain the agreed-upon valuation.
Seller Due Diligence: Here Are the Key Components
Due diligence examines multiple facets of the business, ranging from financial performance to operational, legal, and regulatory compliance. Below are the critical areas where sellers should focus their preparation:
Corporate Records: Buyers need to verify that the business exists in good standing and that its owners have the authority to sell. This review includes examining incorporation documents, governance records, stock ledgers, and other records related to ownership. If any inconsistencies are found in these records, they can delay or even jeopardize the transaction. As a part of the seller due diligence, their legal counsel can help organize these records, reducing potential issues down the line.
Financial Statements and Tax Records: Buyers will scrutinize financial records to confirm the business’s valuation and investment soundness. Accurate, up-to-date financial statements, tax returns, and records are essential. Sellers should collaborate with their accountants to ensure these records are clear, consistent, and ready for review. Any discrepancies, if not addressed upfront, could raise red flags during due diligence and potentially reduce the business’s valuation.
Material Contracts: Buyers look at material contracts to understand the business’s revenue sources, debt obligations, and key relationships. Agreements with employees, suppliers, and customers must be accounted for, and identifying contracts that may be affected by a change of control is crucial. By gathering all relevant documents early, sellers can avoid delays during this particularly time-consuming aspect of due diligence.
Consents and Approvals: During the process of seller due diligence, they must determine if third-party consents are needed before completing the sale. For example, landlords, licensors, or key customers may need to approve the transaction to avoid disrupting the business. Identifying and securing these consents early can help maintain transaction momentum and avoid last-minute hurdles.
Disputes and Litigation: Active or potential litigation will concern any prospective buyer. Sellers should disclose any lawsuits or claims, as buyers will factor these into their risk assessment. Consulting with legal counsel to develop a disclosure strategy can help reduce any potential negative impact on the deal.
Best Practices for a Successful Seller Due Diligence
To ensure the due diligence process goes smoothly, sellers should adhere to these best practices:
- Thorough preparation is key in seller due diligence process. Keeping financial and operational records organized and up to date can prevent unnecessary delays, excessive inquiries, and added costs. The longer the due diligence process takes, the higher the risk of deal fatigue, where one or both parties lose interest.
- Agreeing on terms such as EBITDA adjustments, working capital, and net debt upfront can help prevent disputes later. Seller should also identify decision-makers within the buyer’s organization to streamline negotiations and avoid communication breakdowns.
- Clear, accurate information that is easy to understand builds buyer confidence. Poor-quality or outdated information can increase perceived risk, prompting buyers to renegotiate the terms of the deal.
- One of the most commonly overlooked obstacles in seller due diligence is ineffective communication. Designating a primary contact—whether an internal team member or a financial advisor—helps keep all workstreams aligned. Regular, clear communication can prevent misunderstandings and foster a positive relationship with the buyer.
- Surprises during seller due diligence can undermine trust and destabilize the transaction. By conducting your own due diligence beforehand and openly sharing all relevant information, sellers can avoid unexpected issues and improve the likelihood of a successful sale.
Vendor Due Diligence: Preparing in Advance
Increasingly, sellers are opting to conduct a vendor due diligence before even approaching potential buyers. By conducting a self-assessment of the business’s operations, financial records, and compliance status, sellers can identify and resolve issues that might delay the process later. This preparation offers two key benefits:
- Speeds up the buyer’s due diligence by addressing foreseeable issues upfront.
- Minimizes renegotiation risks by presenting a clear, well-documented state of affairs.
A vendor due diligence report also reflects positively on the seller’s professionalism, reinforcing buyer confidence in the accuracy of the information provided.
HP’s acquisition of Autonomy is a cautionary tale, but it also underscores an important truth: sellers hold the power to shape their own story in due diligence. Instead of waiting for a buyer to uncover potential risks, sellers who actively manage the narrative by thoroughly vetting their own financials, contracts, and legal standing can set the stage for a transparent and successful transaction. By proactively addressing any potential red flags during seller due diligence, it will not only preserve the deal’s momentum but also reinforce the value of their business, ensuring that due diligence becomes a pathway to growth rather than a hurdle.
At MS, we specialize in guiding the process of seller due diligence, ensuring that you are well-prepared to impress potential buyers. Our expert team helps organize financial statements, contracts, and compliance documents, highlighting the strengths of your business while mitigating risks. With our tailored support, you can handle due diligence with confidence, enhancing your chances of a successful sale and maximizing your business’s value.
