2018 Fall issue of Horizons

As M&A activity has surged due to an influx of private equity firms and capital that have entered the market, the M&A process has continued to evolve. More and more companies are realizing the importance of preparing the company for sale in order to maximize the potential return on sale. As a result, businesses are increasingly turning to sell-side due diligence to help prepare for sale. What is Sell-Side Due Diligence? Sell-side due diligence, also known as a sell-side quality of earnings, is a process completed on behalf of the seller that occurs prior to marketing the company for prospective buyers. Similar to buy-side due diligence, sell-side due diligence usually involves an analysis of the seller’s business, operations, historical results and, if applicable, financial projections, with a particular focus on adjusted EBITDA. The primary goal of sell-side due diligence is to minimize surprises during the transaction process and give prospective buyers the confidence to put forth an aggressive bid, knowing the adjusted EBITDA has been supported. Differences Between Sell-Side Due Diligence, Investment Banking & Audits The primary goal of investment banking is to position a company for a successful sale. In other words, investment bankers seek to portray a company in a way that is most advantageous to the seller. On the other hand, the primary goal of sell- side due diligence is to prepare a company’s management for a rigorous buy-side due diligence process, while minimizing surprises and the likelihood of a large adjustment to the presented EBITDA. While investment banking almost exclusively focuses on the positive aspects of a company, sell-side due diligence teams are tasked with identifing potential issues and offering suggestions for how to deal with those issues in a transaction.

Although sell-side due diligence may also illustrate the positive aspects of a seller, identifying issues can prepare the seller to answer potentially difficult questions during negotiations with prospective buyers and during the rigorous buy-side due diligence process. A common misconception is that an audited company does not need to undergo sell-side due diligence when preparing for sale. While an audit is definitely beneficial in providing comfort to prospective buyers the reliability of a company’s reported financial results, sell-side due diligence focuses more on determining what normalized level of EBITDA can be supported in a transaction context – a task that is not performed in an audit. Normalized EBITDA is generally determined through making adjustments to a company’s earnings (i.e., EBITDA), for one-time, non- recurring events and/or deviations from generally accepted accounting principles, among others. The normalized EBITDA calculation, commonly referred to as a quality of earnings analysis, is the critical area of focus for buy-side due diligence teams. Emergence of Sell-Side Due Diligence Recently, sellers in the market, in particular private equity firms, have recognized the importance of sell-side due diligence when preparing businesses for sale. Specifically, private equity-backed companies are beginning to require portfolio companies to go through sell-side due diligence prior to selling. Private equity firms view sell-side diligence as a way to prepare portfolio company management teams for the detailed examination connected with the sales process. Having an awareness of key concerns or issues that may arise during the sales process can often minimize surprises that may be uncovered by buy-side diligence teams and result in better deal outcomes.

Fall 2018

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