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Check assets before you put them up for sale
May, 08th 2008

Vendor due diligence can help sellers optimise transaction value, improve the efficiency of the sale process and prepare for a rigorous scrutiny of their business and financial information by potential buyers.


Do you check things before you sell them? Perhaps, sometimes. Maybe our day-to-day activities do not require such exercise but more and more number of corporates should be well off doing just that, before they sell some assets. Thats what is called vendor due diligence, or VDD in short.

Vendor due diligence is a due diligence review commissioned by a seller or vendor on a business or assets being offered for sale. The scope of this exercise is determined by the vendor and usually comprises financial, tax, commercial and operational due diligence, says Mr Ashish Singhal, Associate Director (Transaction Support Group), Ernst & Young India. Sellers desire maximum value with speed and certainty while buyers, supported by professional advisors, are savvy value seekers, adds Mr Singhal. He broaches on a number of topics surrounding VDD and tells why it might reduce the level of buy-side due diligence to a large extent. Over to the expert

Excerpts from the interaction:

What is a vendor due diligence?

Few years ago, the term sell-side due diligence would have puzzled many corporate development officers and investment bankers. Today, the phrase has made its way into corporate boardrooms, and vendor due diligence is fast becoming an integral part of the sell-side process in any M&A transaction.

Sellers today include private equity (PE) houses planning to divest/monetise their holding in the target companies, or companies requiring capital infusion, and companies planning to divest non-strategic/non-core assets.

The transactions environment in India has witnessed a change in recent years much in line with trends seen in the European market, with a gradual shift in focus and effort from buy-side due diligence to sell-side work. This has largely been driven by the increase in the number of PE investors active in India and emergence of a new generation of more sophisticated buyers and sellers who are used to standardised sell-side processes.

Who starts VDD?

Vendor due diligence (VDD) is a due diligence review commissioned by a seller or vendor on a business or assets being offered for sale. The scope of this exercise is determined by the vendor and usually comprises financial, tax, commercial and operational due diligence. In some cases, depending on the size and nature of the business, vendors may also commission IT and HR due diligences.

How does it differ from buy-side diligence?

In a conventional buy-side due diligence, work is done by a due diligence team on behalf of the buyer or the investor and the focus is on the key agenda of the buyer. In the case of a VDD, the objective is to conduct a due diligence review based on buyers anticipated needs from a due diligence.

As a result, experience of the transactions landscape and knowledge of different potential buyers concerns and expectations from a due diligence become key to selecting a VDD service provider who can present relevant analysis and answers to potential concerns in a ready format as part of the VDD process.

There must be challenges faced by the seller while doing a transaction. Will VDD help?

There are lots of challenges for the seller in todays market. Sellers desire maximum value with speed and certainty. Buyers, supported by professional advisors, are savvy value-seekers. Buyers are always looking for ways to challenge forecasts and past operating performance in an effort to gain a negotiating advantage and to reduce the selling price. There would be hardly any transaction that would not benefit from a vendor due diligence before the business is introduced to the buyers for due diligence. Doing all the work that buyers are likely to do and doing it up front has allowed many sellers to avoid pre- and post-closing surprises and be prepared to address discrepancies or problems before the buyer spots them.

Buyers are willing to pay more for companies they know and trust; inaccurate information and evasive or unprepared management have caused many buyers to walk away.

What makes VDD effective?

Undergoing a due diligence is a fairly onerous task for most companies, especially those which havent been subjected to detailed audits and dont have sophisticated information systems to generate the information required for a due diligence.

Proper planning and a well-scoped and detailed VDD report normally result in substantial time savings for the seller. This saving in the transaction timeframe is easily monetised by sellers who would have earlier access to the capital/purchase price they are seeking to realise from a transaction.

All this was focused on the buyers. What do I gain, if I as a seller, commission such an exercise?

A VDD can help sellers optimise transaction value, improve the efficiency of the sale process and prepare for a rigorous scrutiny of their business and financial information by potential investors/buyers. A VDD establishes a fairly clear value proposition for the seller and it assists the seller in the disposal process to maximise value by identifying potential deal-breakers to avoid costly surprises and allows the seller to mitigate some of these issues before the business is actually offered for sale.

Also, VDD highlights any potential upsides and synergies in the business, allowing the seller to take these into account as part of negotiations with potential buyers.

Second, the maximisation of efficiency. This is enabled by speeding up the sale process as the potential buyers are better prepared. Also it prepares the seller management for meetings with the prospective buyers and for handling their questions.

Control is the third benefit. VDD ensures control over the disposal process and the flow of information to the prospective buyers during the process. This also helps create a level-playing field for prospective buyers and enables the seller to maintain the competitive tension, which is integral to create value for the seller.

Minimising disruption is another benefit. This helps in the day-to-day functioning of the seller. VDD is aimed at answering the potential questions of the buyer and thereby limiting the need for extensive multiple due diligences by potential buyers and allowing seller management to focus on the key deal issues and running the business.

What value do investment bankers find in it?

VDD is not only important for the seller, but also it assists the investment banker to sell the business more clearly, quickly and with fewer uncertain risks. A thorough VDD would reduce the transaction risk. It helps the vendors strategy and numbers to stand-up to independent scrutiny, increases the credibility of the teaser and the information memorandum, can act as a source of pragmatic deal-focused solutions. Plus, VDD can help management prepare for Q&As and presentations along with providing ample comfort to bidders through face-to-face meetings.

One key doubt. Will VDD mean end of buy-side due diligence?

The answer to this question may vary from transaction to transaction and is dependent upon various factors, including the positioning of the buyer and the seller and the internal protocol of the buyer. However, VDD would reduce the level of buy-side due diligence to a large extent.

VDD reports are prepared with the objective of answering key questions which a buyer will have while evaluating the business and which a buyer would expect to get covered in a buy-side due diligence. VDD also has its own limitation like it doesnt contain transaction advice for the buyer and may not address all the items on the agenda of the buyer.

How will the buyer get comfortable with a VDD done on behalf of the seller?

While a VDD is commissioned by a vendor, the work is done by a service provider with the understanding that the duty of care will be transferred to the successful buyer and the buyer can place reliance on the VDD report. This would obviate the need for a potential buyer/investor to re-perform the procedures carried out as part of a VDD.

What are the top and fundamental questions VDD should address?

The key fundamental questions which VDD report should address are as follows:

View on the comfort and robustness of the numbers.

What are the underlying and pro forma earnings of the business?

What is the profile of historical and forecast growth and to what degree are the forecast assumptions supported by the historical growth?

What is the view of the current year outturn and the next years forecast?

What potential cost savings and other synergies exist?

How does EBITDA convert into cash?

What is the definition of working capital? What is the quality and expectation of the working capital at completion?

What will the buyers funding requirement be for the first 12 months running the business?



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