Why You Should Carry Out Reverse Due Diligence

Jan 22, 2021

Reverse due diligence is the process where a Seller whose business is being acquired conducts some due diligence on the buyer.  This is to check their finances are sound and to review key aspects of their business model.

It is standard practice for the buyer to conduct due diligence on the target, but why should the seller do it on the buyer?

If the buyer is paying cash on completion and the seller is sailing off into the sunset with a cheque in his or her back pocket, it may not be too much of an issue. However, even in this situation, business owners often maintain a loyalty to their staff and customers and want their business to continue, so may want to check the history of the buyer on previous acquisitions.

If the seller is not being paid the full sale price on completion, then the financial health of the buyer and its history of paying on time (or not) becomes more important. A phone call to previous sellers to the same buyer is a good starting point if possible, along with a review of their accounts.

It is sometimes possible to secure payments due as part of deferred consideration (payment in instalments over time), but most buyers resist this, so a seller is reliant on the buyer paying.

Where there is not only deferred consideration but also an element of earn-out, where the price paid is dependent on the performance of the business after completion, then reverse due diligence becomes even more important. The seller needs to ensure that the buyer will run the business well so it generates the numbers required to get the maximum pay-out. A well drafted agreement will contain some seller protection clauses to stop the buyer hiving off business elsewhere or deliberately deflating numbers, but confidence that the buyer will run the business well is key for the seller’s protection and peace of mind.

The other end of the spectrum from walking away with a cheque is where the seller joins the buyer. We often see this in professional practice mergers where some or all of the selling partners join the buyer’s firm. In this scenario they need to protect their deferred consideration and earn-out, but also make sure they are joining a firm with the right culture, values, processes and financial probity to ensure their continued successful and contented careers.

We have seen too many cases of partners in firms where they are not happy, but also where they have no leverage to protect their deferred consideration or earn-out. In these scenarios reverse due diligence is key to see the sort of firm they are joining. We will ask about employment practices, complaints, disputes, financial history and a range of other topics to give the seller some comfort.

We will also, where possible, negotiate some reverse warranties into the sale agreement so that, should any of the information provided to turn out to be untrue, the seller has some recourse.

If you’re looking to sell, do talk to us about how we can help protect you.

Law Firm Merger, Bennett Briegal