Vendor Due Diligence

This week's buzz phrase is Vendor Due Diligence.

Competition for private equity investment opportunities just keeps growing. This is particularly true at the upper end of the market where virtually all transactions are now conducted as competitive auctions.

These auctions (which can include ten or more bidders) create difficulties for both bidders and vendors. Two obvious problems are:

1.  The costs incurred by unsuccessful bidders.  A full due diligence can run up a bill in the millions of dollars.  This becomes an expensive hobby if you miss out on two or three deals in a row.  Due diligence also soaks up time that could be spent chasing other investment opportunities. 

2.  The unacceptable impact on the target business.  Responding to due diligence queries from multiple bidders can become a full-time job for the senior management team.  I have watched companies virtually grind to a halt during prolonged due diligence.

To avoid these complications vendors are increasingly employing Vendor Due Diligence.  Instead of allowing each bidder to conduct their own review, the seller pays a top-tier accounting firm and law firm to prepare one set of comprehensive reports for all parties. 

Areas covered by Vendor Due Diligence typically include historic and forecast financials, earnings normalisation, working capital and cash flow analysis, pension funding adequacy, and identification of tax and legal liabilities.  Sometimes the report is extended to include areas such as IT systems, environmental, and insurance.

Comments

[fred]

i understand why the sellers do this but i would never rely on a third party for due diligence. how can you be sure they got it right?

[james]

thanks for another great post. i love it when a company looking for cash has put the time effort and money into putting together a due diligence package. while i agree with fred that you need to do your own due diligence, it shows that the company is serious and is prepared to take an investment. even better is when the company is already producing quarterly and yearly reports that can be updated into their DD binder to show that they have a history of monitoring their metrics of growth. i will not hesistate to take their binder, do my own DD and call them on any inconsistencies.

[Daniel]

Good heavens, I knew it would hapen one day. Three cheers for the first Aussie vc blogger.

Nice site GP.