Managing the Sale Process:
Due Diligence – A Very Important Game of Show & Tell
By Christopher Kelleher
The Positive Influence of the Due Diligence Process
Due diligence is the process by which a buyer can either talk himself into buying something or talk himself out of it. Assuming the seller really wants to sell, he’d best get organized and take this part of the sale process very seriously. The broad due diligence categories and the critical elements in each category are enumerated below.
The due diligence process is invariably intrusive and time consuming, but a well-organized seller can greatly reduce the frustration and expense that often plagues the unprepared. Prior to launching the sale process, your investment banker should work with your CPA, lawyer, construction manager and administrative staff to build a comprehensive and thoughtfully organized virtual data room.
The buyer’s impression of the quality of the organization and its management team will be significantly influenced by the due diligence process. Done right, the potential buyer comes away confident that he is bidding on a business that has its act together. Done poorly, the potential buyer becomes anxious and tentative.
Perhaps even more important than being well organized is being transparent. Hiding the soap is always a very bad idea. We are not saying to put your ugliest kid in the center of the family photo, but he does need to be in the picture. There is no harm in emphasizing the most positive elements of your story, but never purposefully provide incorrect information or overtly hide problems. If you do, and you get caught, you’re screwed. If you get caught before the deal closes, the buyer will either run for the hills or become distrustful and very difficult to deal with. If you get caught after the deal closes, you’re going to get sued and you’re going to lose a lot of money.
Categories and Critical Elements
Facilities—80% of the Issues are Roofs and Parking Lots
- Informal Site Visits—Pre-bid
- Site inspections—Formal post APA
- Roof inspection—Buyer or seller’s roofer?
- Equipment inventory and testing
- Refrigeration and HVAC testing
- Capex history
- R&M vendor list
- In-house maintenance team should chaperone buyer’s team
- Preview buyer’s inspection checklist
- Buyer’s repair list provided to seller on a timely basis
- Who pays for what?
Employees—When to Provide Access is Critical
- Management meeting
- Employee turnover meeting
- Employee files
- Employee handbook
- Employee benefits
- Vacation pay—Paid out or transferred
Property—Maintaining Complete Property Files is the Key to Minimizing Seller Costs
- Lease review
- Lease assignment
- Title review
- Zoning letter
- Property tax bills
- Title objections letter
- Environmental review: Phase 1 and 2. Watch for vapor intrusion issues
- Who pays for what?
Financials—Full Disclosure Via Complete and Detailed Financial Records is Crucial
- Last three years of monthly unit level P&Ls
- Last three years of corporate financial statements
- Last three years’ detailed overhead schedule
- Access to franchisor sales/royalty data
- Provide access to buyer’s forensic accountants
- Detailed back up for any pro forma adjustments
- Quality of earnings test
Franchise—Hopefully the Franchisor Won’t Screw Things Up For You
- Franchise agreements
- Development agreement
- Franchisor development mandate
- Franchisor remodel mandate
- Franchisor performance reviews
Miscellaneous—Unfortunately This Stuff is Important, Too
- Contracts: Safes, POS, security cameras, propane, telecom
- Contract assignment
- Permits and licenses
- Insurance loss runs
- Legal claims history
Some buyers are more focused on the financial disclosures, while others concentrate on the facilities. Typically, but not always, larger deals involve more sophisticated buyers and the due diligence process is more robust. Deals involving private equity buyers, particularly when it is the PE firm’s first foray into the restaurant industry, can be extremely rigorous involving Big Four forensic accountants doing quality of earning analysis, building engineering climbing on roofs, equipment technicians testing every toaster and high ticket Wall Street lawyers going through every shred of paper in the data room, twice. If you want top dollar for your business, you’re just going to have to put up with this crap. Get organized, be prepared and always remember:
YOU’RE PLAYING SHOW AND TELL, NOT HIDE AND SEEK.
Chris has more than 25 years of experience in capital formation, M&A advisory, debt restructuring and strategic advisory services to multi-unit restaurant industry entrepreneurs. Chris is a frequent author on franchise finance related matters, and his views are regularly published in the Restaurant Finance Monitor, and Franchise Times, among others. He received his undergraduate degree, with honors, from Occidental College. Chris earned his MBA in finance and accounting from UCLA’s Anderson Graduate School of Management.