Due Diligence: A Deal It Killed
24 February 2025: Due Diligence: A Deal It Killed
“Murder!!” That’s what the seller called it. But in reality, the death of this deal was suicide.
We’ve posted fairly often about the due diligence process – from both the seller’s standpoint (as in what to expect) and from the buyer’s standpoint (as in how to approach it). From the seller’s standpoint, the underlying issue that must be understood is that the process of due diligence – its depth and intensity – varies from buyer to buyer, a fact that underscores the need to “know your buyer”.
For example, financial buyers – the buyers of most small businesses – generally perform what most professional business brokers would characterize as “basic” due diligence. They’ll want to see the financial statements and tax returns, proof the business is in good standing with the authorities, that it’s not in violation of any of its contractual agreement such as leases, licensing, franchise, etc. If such financial buyers are properly advised, they’ll ask for organizational documents to confirm the ownership of the business.
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Strategic buyers will certainly want to see all of that but they’ll probably go deeper. They want to make sure the target company has no reputational or legal issues that could carry over to the acquiring company. A tax claim or environmental problem are examples.
But financial and strategic buyers are just the two general categories of buyers. There are sub-categories, one of which is private equity firms (“PEGs”). There are even sub-subcategories. Some PEGs want to acquire 100% of the businesses they’re targeting while others want simple control. In effect, they’re buying the existing talent – the owner/seller and the management team.
This post is about the latter.
A deal one of the brokers in our network was working on was nearing the closing date. The business in question – about 12 years old – was an essential service and growing. Several PEGs had been circling and two had submitted letters of intent, one of which the broker successfully negotiated into a purchase agreement. The acquisition price was $7 million.
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Don’t Miss Out on the “Silver Tsunami”!
The buyer wanted the seller to stick around for a while in a consulting capacity rather than as an earn out. The seller was amenable to this and the starting gun sounded on due diligence.
When we discuss due diligence in our courses – which we do often – in a feeble attempt at humor when trying to describe how intense they can be, we equate them to a proctology exam. They can feel that invasive!
Our broker often brought that term up during our twice weekly support sessions in a way that suggested he thought we, when making that comparison, were being somewhat hyperbolic. After this experience, he has changed his tune. The buyer’s due diligence was an epic lesson in “thoroughness”.
In the course of this intense scrutiny, there were two meetings between the buyers and the sellers. They went through everything the broker advised his client to be prepared for and more. The buyers wanted the seller to stay on and wanted to make sure that there were no secrets or issues in the seller’s past that could prove problematic should the buyers’ investors find out about them.
During the first face-to-face meeting, the buyers asked about this and the seller disclosed a personal legal issue that he went through several years earlier. The buyers responded that they would give this some consideration but emphasized the importance from their standpoint, and that of their investors, their need to know everything – the good, the bad and the ugly – about the business and the man they were “investing in”. The meeting ended cordially and, because the balance of the due diligence was over with all questions apparently settled, the seller and broker were fairly confident that the deal was on a glide path to closing.
Then the PEG hired a private detective.
It turns out that more than 20 years earlier, the seller, during his misspent youth, committed a relatively minor indiscretion. It was so far in the past and seemingly insignificant that he didn’t feel the need to disclose it. The private eye found it.
In the subsequent meeting between the parties, the buyers brought this issue up. The seller defended his decision by stating the length of time that had elapsed and the relative insignificance of the event. The buyers would have none of it. They terminated the deal on the spot.
The reason stated was that, when they asked for “full disclosure”, the seller withheld this long ago issue and, as such, trust was lost. The veracity of everything else the seller disclosed – from employee information to financial data – was now called into question. Our broker, who was sitting in on all these meetings and had spent countless hours over nine months to get this deal to the closing table, watched a major payday vaporize before his eyes.
The Bottom Line
We’ve written about the need to “know your buyer” before and this is just one example of the reasons why.
Different buyers have different needs and objectives when shopping for a business and it’s imperative that sellers – and particularly their brokers – understand what the due diligence period is likely to entail so that they can be prepared for what, in many cases, will be an extremely invasive process.
And finally, if your buyer is a private equity group and you hear the term “full disclosure”, remember what the definition of “full” is. Failure to comply runs the risk of losing a “done” deal.
If you have any questions or comments on this topic – or any topic related to business – I’d like to hear from you. Put them in the comments box below. Start the conversation and I’ll get back to you with answers or my own comments. If I get enough on one topic, I’ll address them in a future post or podcast.
I’ll be back with you again next Monday. In the meantime, I hope you have a safe and profitable week.
Joe
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The author is the founder, in 2001, of Worldwide Business Brokers and holds a certification from the International Business Brokers Association (IBBA) as a Certified Business Intermediary (CBI) of which there are fewer than 1,000 in the world. He can be reached at
jo*@Wo*******************.com