Texas M&A Due Diligence: What You Need To Know

Co-written by Cliff Atherton (GulfStar Group), Larry Wilson and Mary Pilson (BoyarMiller)

We hear the term “due diligence” a lot. It’s been in use since the mid-fifteenth century to mean the requisite effort necessary to accomplish a specific end, as in “he exerted due diligence to plow the field before nightfall.” By the middle of the 20th century, it was enshrined in the legal lexicon as a defense against liability for a false statement under the Securities Act of 1933. In negotiating mergers and acquisitions, it is the process by which the buyer documents facts and beliefs about a target company.

Any owner who has sold a business knows that its true meaning is: “a list of unreasonable requests for irrelevant information and nonexistent documents and endless meetings with people that don’t know the right questions to ask or understand the clear answers provided.”

Regardless of how you feel about it, it’s a necessary part of the M&A process, and the sooner and more thoroughly you prepare for it, the quicker and less painful your deal will be.

One of the first documents that a seller receives after signing the Non-Disclosure Agreement and the Letter of Intent is the buyer’s initial Due Diligence Request List (the “DRL”) asking for such things as:

• Organizational Structure
• Financial Information
• Tax History
• Assets
• Liabilities
• Operating Methods and Procedures
• Business Relationships
• Employees and Employee Benefits

Buyers frequently assemble a team of experts to conduct due diligence, each in a specialty area: attorneys to review organizational structure and legal documents; forensic accountants to review financial and tax information; appraisers; operations managers, HR professionals, environmental consultants, and others. Unlike the preliminary information provided in connection with the negotiation of the Letter of Intent, the DRL will ask for documents and detailed information for each of these specialties.  You will feel like you have been called before the Spanish Inquisition, and some poor soul in your organization must take responsibility for coordinating your company’s responses to each line in the DRL. Take care to provide as much of the information as possible as quickly as it can be made available – and be prepared to provide some responses more than once.

Once you have provided more information than you think is necessary, you might be tempted to take a break and give yourself a pat on the back. Don’t. You aren’t done. As surely as death and taxes, the DRL will be followed by calls for missing documents, one or more supplements to the DRL, due diligence meetings with the buyer’s representatives to answer questions, more supplemental requests, meetings with your representatives to go over the Schedules to be attached to the Purchase Agreement … it’s exhausting just writing it all down. But it’s necessary.

When responding to the buyer’s requests, you are not only helping the buyer get to the closing table, but you also protect yourself and your sale proceeds. A virtual data room managed by your investment banker or lawyer is a convenient means to share information with your buyer, and it creates a permanent digital record of the information you provided and when it was accessed by your buyer.

Taking the time and care needed to respond to the buyer’s information requests will prevent surprises later and save you time and money (and no small amount of gray hair) in the long run. Also, the process provides you with an opportunity to confront and discuss any uncomfortable issues, explain any misconceptions, identify and allocate the risks associated with the ongoing business and, occasionally, discover additional value or opportunities.

Difficult questions that sometimes arise include:

• Should you raise topics that the buyer overlooked?
• How should you respond to a request for information that’s protected by attorney-client privilege or a confidentiality agreement?

These are issues you should discuss openly with your legal and financial representatives. There is no single answer, and each case is different. Sandbagging, for example, is an important circumstance for discussion in a later article – stay tuned.

The main thing to remember is that the due diligence process is designed to answer the buyer’s questions about the company and to create a robust record of your responses.  Diligently executed, the process will provide the basis for all parties to reach reasonable expectations about the business and the transaction and negotiate a mutually acceptable Purchase Agreement with a minimum of drama.