A guide to vendor due diligence
19 January 2017
Vendor due diligence – or sell-side due diligence – is the process a private business undertakes when it is either being sold or when assets of the company are up for sale. Unlike buy-side due diligence, vendor due diligence is conducted at the request of the seller.
Usually conducted by an independent third-party, a comprehensive report of the company's financial stability is produced and made available to potential investors. The potential buyer's financial and legal teams will then review the report to determine the financial solvency and prospects of the company being sold, as well as to alleviate any concerns surrounding the vendor before proceeding with the acquisition.
Vendor due diligence process
At a high-level, the vendor due diligence (VDD) process contains the following stages:
The first step involves the vendor liaising with a third-party to conduct the due diligence on their behalf. This process usually commences just before the target company or company assets are put up for sale.
A draft Vendor Due Diligence Report (VDDR) is then prepared and sent to all interested parties for review, after which the vendor allows potential buyers to carry out their own due diligence.
Depending on the type of sale and complexity of the transaction, bidders may conduct interviews with the target company's management.
Once the sale is complete, the buyer receives the final VDDR to which they are legally bound.
What are the benefits of conducting vendor due diligence?
The primary benefit of vendor due diligence is that it increases the probability of success of a proposed acquisition, by instilling buyer confidence and credibility in the company's potential. A VDDR provides prospective buyer with a clear view of the business before negotiations even begin.
Vendor due diligence enables the seller to identify and address issues relating to company assets early on, which can result in a higher selling price as well as speeding up the process as a whole.
By providing a draft report that fully discloses any liabilities or material risks, the vendor can prevent initial bids being later negotiated down upon the discovery of these problems during later due diligence.
If there are multiple bidders interested in the target company, it is prudent to produce a report before the buyers' due diligence teams conduct their own investigations.
This will help to reduce the number of questions from their legal and financial teams, and make better use of management's time.
As all interested parties have access to the same VDDR, the bid process remains competitive, which will likely result in a higher value for the acquisition of the target company.
Access to key company information early in the acquisition process allows potential buyers to save costs on buy-side due diligence, and make informed decisions if any significant issues are identified.
Vendor due diligence checklist
The contents of a VDDR will often vary due to the nature of the target company being audited; however, the contents of the report will largely remain similar across most industries.
The main types of information typically present in the report include:
A complete review of the vendor's historical financial information
Quality of earnings – a summary calculation of free cash flows (FCF). Free cash flow is the measure of the cash flow the company produces after deducting the expenditure on assets.
Risk evaluation – this encompasses capital structure, liquidity, and a detailed growth analysis.
Debt – the vendor must be transparent about any contingent liabilities that were not disclosed in financial statements.
Other issues – those that may be exclusive to the vendor or industry. This may include the influence of related-party relationships, complex international aspects to the company that may have an effect on transfer pricing or taxation, or significant changes in the regulations of the industry of the vendor.
Extra information that may also be included:
- Intellectual Property
- Material Contracts
- Strategic Fit
- Customer / Sales
How DueDil can help
From due diligence to deal prospecting, DueDil helps businesses make data-informed decisions. DueDil combines comprehensive sources of company information and an intuitive set of features that allow any team to uncover opportunities and understand risks.
Unlike traditional information suppliers, DueDil provides a unified platform for teams across a business to contextualise and navigate the relationships between sets of data.
To find out how your business can enhance it's due diligence processes, get started with DueDil today.