Selling a rental business; What does “due diligence” mean?
QUESTION: I’m in the middle of selling my business to a qualified buyer who finally offered me a reasonable price for my business, but his attorney is asking for a lot of information. He keeps calling it “due diligence,” but I’m not sure if I’m comfortable providing all of this information and he’s driving my administrative assistant crazy. How much should I be disclosing and is there a point where I should just refuse to provide any additional information?
Answer: First, congratulations on finding a qualified buyer, which can be difficult. If you’re like most sellers, you probably provided certain limited information to a broker or perhaps a list of potential targets in order to identify a group of potentially qualified buyers and entice one or more of them to request additional information. Rarely do buyers make an offer based on this initial and usually very limited dataset.
Due diligence. Definitions may vary, but according to Black’s Law Dictionary, 2nd Ed., it means: Such a measure of prudence, activity, or assiduity, as is properly to be expected from, and ordinarily exercised by, a reasonable and prudent man under the particular circumstances; not measured by any absolute standard, but depending on the relative facts of the special case.
My definition may make more sense to you as a seller: A potential buyer’s investigation of your business in an effort to determine whether the buyer should or should not purchase it.
Commencing the due diligence process. You should expect most reasonably astute buyers to request certain basic information regarding your business in order to make certain the business really is a candidate worth pursuing — in terms of its assets, customer base, profitability, personnel, location, service offerings, legal and tax status, and much more. Broadly speaking, this is the buyer’s “due diligence.” Although potential buyers may request any number of pieces of information based on what they know or suspect about your business, you should be prepared to provide at least the following initially — but only after the potential buyer signs a “confidentiality” or “non-disclosure” agreement:
- Name and address of business.
- State of organization and Certificate of Good Standing.
- List of owners and ownership percentages.
- Unaudited financial statements for the business for at least the past three years.
- Tax returns for the business for at least the past three years.
- Asset inventories (furniture, fixtures, equipment, supplies, etc.) to be included in the sale.
- Fleet aging by category if available, by time/hours.
- Estimated values by category if available — depreciated value, current market value and replacement cost.
- List of locations and facilities, including showrooms, yards, repair and maintenance facilities, storage facilities, wash bays/cleaning facilities, sales areas, etc.
- Photos of facilities and equipment.
- Numbers, specialties and types of employees and contractors, both full and part time.
- Special considerations. For example, Tier 3 and 4 equipment, telematics, specialized software, limited competition, exclusive dealership arrangements, new or upcoming projects, etc.
Further due diligence. Remember, the above only is the initial list of due diligence requests you can expect. Upon the potential buyer’s completion of its review of the above disclosures, the buyer may make an offer, which will virtually always be contingent upon the buyer’s satisfaction with the results of its remaining due diligence investigation; request additional disclosures — which requests are usually more limited, though we do sometimes see buyers acting more aggressively; or terminate negotiations.
Letter of intent/memorandum of understanding. If the buyer elects to continue negotiations and proceed with more due diligence, it is customary for the parties to sign a largely non-binding letter of intent (LOI) or memorandum of understanding (MOU) setting forth the basic deal terms in summary form. Commonly, the only parts of an LOI that are binding are the confidentiality, deposit and breakup provisions, identifying the parties’ respective rights and remedies if the transaction is terminated. MOUs often are considered more broadly binding and enforceable.
After executing the LOI or MOU, you should expect a much longer list of disclosure requests, including copies of all relevant contracts, titles, books, records, audits, reports, investigations, legal pleadings and other relevant materials. Depending on the size of your operation, you may want to consider setting up a data room dedicated to the production and copying of such materials.
Here are a few important things to bear in mind when responding to a potential buyer’s due diligence requests:
- Be careful of “standard form” confidentiality agreements presented by potential buyers. They rarely provide much if any protection for disclosing sellers.
- Read LOIs and MOUs carefully. People often mistakenly assume LOIs and MOUs are entirely non-binding. Though that often is true, it may not be, particularly with respect to confidentiality requirements, deposit provisions and breakup fees.
- Don’t over-disclose. Even the best confidentiality agreement won’t fully protect you. Be careful what you disclose and to whom. Provide summaries rather than item- or customer-specific information whenever possible. Disclosures of customers, assets and business strategies, among other things, to a financial buyer from another state create different issues than do making the same disclosures to a local competitor. For example, when I represent a seller, I generally advise including only types, categories and quantities of assets, rather than an item-specific list, if possible. For example, “Heavy, medium, light, aerial, mining, industrial equipment, trucks, trailers, and separately, events/tents and other (e.g., storage containers, portable restrooms, ATVs, UTVs, etc.).
- It usually is best not to mention a potential sale to your employees, lenders, dealers, manufacturers and/or service providers until as late in the game as possible. Among other things, doing so may prompt them to restrict or even terminate their relationship(s) with your company, demand price or salary increases, perform audits, and/or require large deposits and/or advance or C.O.D. payments.
- Security is vital. Make certain only those parties with proper authority are permitted to review your due diligence data and have access to your data room.
A more general discussion of the acquisition and sale process: If you’d like a broader view of the process of buying and selling a rental business from the seller’s vantage point, take a look at the “Legally Speaking” article published in the November 2016 issue of Rental Management on page 26. It also can be found online at RentalManagementMag.com. Click on the “Past Issues” tab, the November 2016 cover and then click on “Legally Speaking: Selling a rental business” under the “Rental Ideas” heading.
When selling a business, it pays to be careful and to engage only with people familiar with the process. Complacency can yield unpleasant and potentially expensive surprises. This is particularly true in light of the recent changes to the federal tax code, discussed in the May 2018 Legally Speaking article.