What is Vendor Due Diligence?
Vendor Due Diligence is the due diligence report that is initiated by the side of the seller, normally by the company itself or the majority shareholder. This process is carried out by independent third parties that are chosen by the seller. The report can be described as an investigation and analysis of the company’s finances, legal matters, market sector analysis, management team and more.
What type of information does the Vendor Due Diligence contain?
The sort of information in the vendor due diligence report tends to include the following:
- A complete review of the seller’s historical information
- The quality of the earnings with a calculated summary of the free cash flow (FCF)
- Evaluation of the risks, including the capital structure, the liquidity, and a detailed growth analysis
- Transparency of the company debt that is not shown in the financial statements
- Important information about the relationships with related parties, international aspects, and the industry regulations
Beyond this main information, they can include intellectual property, insurance, administration, equipment contracts, the clients, and much more.
Differences with Buy-Side Due Diligence
The Vendor Due Diligence process is essentially the same as the Buy-Side Due Diligence process. The main way in which they are different is who initiates them, either the seller (for vendor DD) or the buyer (for buy-side DD).
When should the Vendor Due Diligence process start?
In general, it is better to start the Vendor Due Diligence process from the beginning, before initiating the selling process. This way, the third parties can find important problems and the seller can fix them before the buyers see them. And, if they do not find any problems, the seller knows that the company is ready for the market. Also, by starting early, the seller already knows the value of the company and will be better prepared for the negotiations. Sometimes, the buyer may consider the DD report as enough for buyer’s comfort, and any concern may be included in R&W.
What does the seller learn?
Vendor due diligence provides the seller with a lot of information about the company. Some of the main objectives include: (1) Understanding the possible risks that buyers will see in their organization. (2) Getting a detailed understanding of the problems in their company. (3) Learning about the problems with the contracts. (4) Improving the possibilities of successfully selling the company. (5) Evaluating the order entry in the future to see if they are ready to grow the company. (6) Clearly identifying the people driving the business that are crucial for carrying out tasks for the company in the future. (7) Getting a critical opinion about the buying price and the possible ways to increase it. (8) Starting to polish and improve the business plan. (9) Preparing for the buyer’s questions during the due diligence. (10) Discovering management flaws that are not properly covered (GDPR, compliance, or any recent legislation not implemented). And much more.
Advantages for the Seller
By starting the vendor due diligence before starting the sale, the seller receives a lot of benefits for the negotiation process.
- They have a better control of the sale process. The seller will have all of the information, instead of the buyer, so they will have a bigger role in the negotiations
- They can identify and address all of the problems related to the company assets and practices. By resolving these problems very early on in the process, they can get to a higher selling price
- By providing a draft of a report that completely reveals any important responsibility or risk, they can avoid having the buyer discover something that would negatively affect the price of the sale, and also the reputations of the company and the seller
- It shows the possible buyer a clear vision of the business before starting the negotiations in order to demonstrate that the company is ready and has a bright future
- It saves the administration time so that they can focus on conducting business and so that they do not worry about having surprises
- It reduces the amount of confidential material that is being disclosed to the buyer, which is very important when a possible buyer could also be a potential competitor
Advantages for both sides
Beyond just helping the seller, vendor due diligence provides benefits to the sales process in general, which helps both the seller and the buyer.
- It accelerates the sales process by identifying the possible problems beforehand, which saves time for both parties
- It eliminates the duplication of due diligence work by various buyers that want answers to many of the same questions
- Although the vendor due diligence probably will not completely satisfy many different buyers, it still reduces the due diligence that they conduct
- It provides better credibility to the facts and numbers that the seller presents to the potential buyers since they have been verified by impartial accountants and lawyers. It also allows both parties to refer to the same set of credible financial numbers
- It allows for the focus to be directed exclusively to the critical commercial problems, instead of having to determine the accuracy of the numbers
Is it sufficient for the buyers?
Although the vendor due diligence can offer many benefits to the buyers, such as saving time and eliminating the costs of their own due diligence, the vendor due diligence often does not satisfy the buyer. First, they buyers may not trust the third parties that carried out the process. Since the seller chose them, it could create a sense of doubt about the impartiality of the selections. Also, the buyers might think that the process is too much in the control of the seller. If they have control of the flow of information, they can have too much of an influence in the negotiations.