Who can forget the running gag in television comedy of the exploding closet? Lurking behind the unassuming closet door lies utter chaos. Anyone that knows well enough can open the door quickly, retrieve what they need, and hastily shut it in one rapid movement.
This is, of course, a setup for the unassuming character that is sure to be buried in an avalanche of odds and ends in the next scene. This is the perfect metaphor for what we buy-side M&A folks sometimes find when starting due-diligence on a selling company.
Now, I don’t want to imply that your business is in utter chaos “behind the door,” but I’d be surprised if everything you planned to be documented or processed a specific way is always happening as intended.
I believe you should always be building your company as if you were selling tomorrow. You will certainly run more efficiently and at better margins. Also, when the day comes that you choose to sell, your deal may be improved.
When the day comes that you enter into a Letter of Intent with a Buyer, there is a mountain of materials you will need to provide for proper due diligence. All of this takes time while you are still running your company. Every loose end will require extra time to track down and typically creates more questions to answer. For that reason, it is better to audit things now than be surprised later when it counts.
I’ve prepared a list of the most common areas where we see discrepancies that can undermine a transaction, but are relative easy to remedy. In the end, you’ll be in better shape for any future sale and will certainly enjoy being able to open the closet without ducking. Here’s the list:
Customer Contracts – Randomly sample 10 customer contracts. Are they in digital form with standardized naming conventions? Signed and countersigned? Stored where intended? Able to tie-out to the current relationship? If any in this sample group contradict your policy, you should audit/update all contracts. It is also best to identify any contracts that may require customer authorization to be transferred as that may cause a buyer pause.
Vendor Contracts – You should be able to identify all your current vendors and associated agreements (if any) and be aware of any clause that may require prior authorization to transfer the relationship. This is not that common with vendor agreements but they may exist in things like datacenter or contract-service provider agreements.
Good Standing – This is easy! Contact your Secretary of State to find out if your entity is in good standing. If your business is not in good standing, take the steps (often simple) to rectify. Then set a reminder to keep this up to date.
Employee Docs – Test for documents on all employees. Ensure that all offer letters, contracts, and federal and state documents are on file and signed. We highly recommend that you have NDA/Non-solicits (no customer and other fellow employee/contractor poaching) in place for all employees. Beware of any special compensation, bonus, or commission arrangements that are not documented and do so.
Deferred Revenue – If your business model invoices for revenue in periods before services are provided, you should be funneling that through your balance sheet in a deferred revenue account. Consult your CPA to establish a process. If you already do so, excellent! But, ensure that your month-end balance ties out properly.
Asset Lists – How easily can you pull this together? Many small to medium sized companies rely on their accountant to track assets for depreciation. We recommend having living work-papers that can tie out all active physical assets with serial numbers and location (especially if they are at client sites).
I’d recommend working with your team to test and improve the state of these items. Make it a learning experience for everyone and an opportunity to fix procedures to ensure that you’re achieving the outcomes you expect. Good luck and have at it!
About the Author: Scott LeRoy, VP of Operations and Business Analysis at Cogent Growth Partners, LLC, has over 20 years of experience in finance, marketing, operations, brand development to go along with his M&A chops. He spent a decade in the IT and managed services industry reengineering what IT means to small business and since 2014 has project managed transactions and led business analysis and due diligence efforts for Cogent.
