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In Deal Process

It’s the Little Things that Derail Deals

By: Nick DeRose

Having grown up in the Central Valley, it’s probably a bit of a surprise that I’m a diehard San Jose Sharks fan. I’ve passed this passion on to my son, who at four years old said he wanted to be a Sharks player when he grew up. When I told him that in order to become a professional hockey player, the first thing he has to do is learn how to skate, his reaction was, “I just want to go out and play hockey.” I wish hockey was that easy. But I told him that he needs to focus on the little things to ultimately become a great hockey player and fulfill his dreams of playing for his hometown crowd. When you try to skip over the little things it could cause bigger problems down the road and derail your dreams.

When it comes to selling a company, it is the little things that could make or break a deal. Many entrepreneurs believe that once they get a term sheet then everything should be easy from there on out. However, getting a term sheet is just the beginning to having a successful outcome for the company and the acquirer.

I feel like every entrepreneur that I speak with believes they have all the documents organized and diligence should be a cake walk. While companies that are backed by institutional investors are more organized, they will still be shocked to see the amount of data that will be requested from an acquirer. Most believe that a deal should be closed in a few weeks. What they don’t realize is that in most cases just answering the first round of the diligence requests will take a few weeks – at minimum you might want to budget four to six weeks to get a deal complete.

Once you sign a term sheet, within a few days the acquirer will provide you a due diligence check list. The number of diligence questions will vary greatly depending on the acquirer – I’ve seen some with as few as 400 questions and some with as large as 3,000 questions.

I know you might be saying, “You’ve got to be kidding me? I’m a four-year-old startup, don’t have thousands of customers, have only raised $20m, my financials shouldn’t matter, I have less than 100 employees, etc., so why are they asking all these questions?”

  • Due diligence is a crucial aspect of the process because it enables the buyer to fully
    understand the risks and rewards of the potential deal.
  • The potential buyer will examine the business from all angles so it is best to know and
    understand all your “dirty laundry” before the buyer gets a chance to see it.
  • Ensuring that the technology is defensible and not infringing on other patents is critical in technology M&A due diligence.
  • The buyer wants to ensure that they are not acquiring any unwanted liabilities that could hurt them in the long run.

When you are a startup, typically nobody sues you because you don’t have deep pockets. Unfortunately, we live in a litigation-happy country, so when you are acquired the acquirer is susceptible to lawsuits.

So what will the acquirer be asking for? They will want to know everything about your financials, contracts, intellectual property, environmental issues, employees and benefits, technology, founding/investment documents, taxes, customer details, legal issues, etc. You can find a high level at what an acquirer will request here.  That link just scratches the surface on what they will request. There will be tens if not hundreds of little detailed questions that will be requested under each category.

Here are some helpful tips as you start thinking about the diligence request list.

  • Make sure you have all the appropriate signatures on every document where a signature is required. When signatures are missing, it raises red flags.
  • Expect to have at least hundreds if not thousands of documents needed to respond to the full diligence request list.
  • Be sure you provide complete responses to all the questions. You should expect to get additional questions and requests during the entire diligence phase.
  • Check your email for many of the relevant documents (you’ll be amazed by the treasure trove of documents that will be hidden in there).
  • While some questions may not be applicable, most questions will require a document/s as proof. For example, if they ask a question to provide a list of benefits offered, then you will need to provide all the documents that talk about every plan offered (in some cases could be 20+ pages).
  • When in doubt disclose everything. It is in your best interest and will protect you in the future.
  • Don’t try to do this all yourself. Be sure you bring other members and delegate appropriate responsibilities because diligence is very time consuming and you have to continue running the business.
  • While you may not have audited financials, ensure that you are adhering to the regulatory accounting standards (e.g. GAAP). Otherwise, this could severely delay and impact the deal.
  • The larger the acquirer the more people will most likely be involved. I’ve seen 70+ people become involved in the process even though it was a team of 30.
  • Last but not least, hire a good investment bank because they can help manage the process and keep you on track.

I can’t stress the importance of bringing in an investment bank. Not only will they help you ahead of time in getting you prepared but they help manage the process, ensuring all the appropriate documents (with signatures) are provided, all answers are complete and thorough, timelines are met and most importantly the little things are not overlooked.  A team like the Sharks doesn’t just get to the top by focusing on the big win. They achieve greatness by surrounding themselves with the best support team who helps them master all the small things and keeps them on track to achieve greatness.