Exit planning: Doing your due diligence

By Cindy Jenner Cowan | September 18, 2007 | Last updated on September 18, 2007
5 min read

Buying a practice or a book of business isn’t as simple as signing on the dotted line. If you want to make sure you’re getting the right deal, it’s mandatory that you conduct due diligence. But what exactly is due diligence and why does it need to be performed?

Due diligence is, at its most basic, the process of fact-checking, analyzing and investigating the characteristics of a seller’s practice or book of business to ensure its accountability, credibility and accuracy. During this process the buyer is trying to determine if there are any risks or downsides to the business.

After the buyer has all the facts about the potential business, he’ll be able to make changes to his offer if need be. Things such as the price of the practice and problems with the business could be altered or remedied, and if something is particularly risky or undesirable, the buyer can back out of the deal.

Other issues that due diligence could uncover include:

  • misunderstandings as to the type and condition of the practice or book of business being acquired;
  • incompatible clients;
  • pending lawsuits; or
  • contingent liabilities.

After the seller accepts the buyer’s letter of intent and deposit, he’ll ask the interested party to sign a confidentiality agreement. It’s important that the buyer sign it, so all proprietary information will be kept in confidence.

Once all the documents are signed and sealed, the buyer will have a specified period of time to sift through financial records, operational information, employee records and more, which should be prepared beforehand by the seller.

Needless to say, this process is extensive — usually taking four to six weeks, but it can vary — so it’s important that the buyer sets aside ample opportunity to examine all the records and perform due diligence to their complete satisfaction. The process is only undertaken once, so it’s the buyer’s responsibility to ensure it’s done properly and carefully, and in a timely manner.

Generally, the buyer is the one conducting the due diligence, but occasionally outside resources, such as an attorney or an accountant are retained to help, or lead, the process.

Don’t forget the client

While financial and operational details are all important in the due diligence process, it’s imperative that the buyer and seller not forget the client.

It’s recommended that the buyer and seller allot a full day to review the company’s client list. Why an entire day? By spending time with the seller, the potential purchaser can learn a lot about the investment characteristics of the individual clients and the group as a whole.

To make this part of the process easier, clients should be ranked by revenues generated and potential future increased investments.

Clients are generally not contacted by the buyer during the due diligence process. Exceptions are made, though, when the seller’s book of business has a high concentration of assets with one person, or a small group of clients. In this case, the buyer will set up a meeting to talk to the client at the end of the process or a contingency will be built into the purchase and sale agreement.

It’s important to keep in mind that as the buyer conducts due diligence on the seller, the seller is looking into the potential purchaser too. That’s because the seller must determine if the buyer has the skill, experience, motivation and integrity required to successfully transfer and retain the existing clients.

To do this, the seller will look at the regulatory background of the purchaser and their credit history.

For the buyer, delving into the practice’s history is easier said than done. A number of things need to be researched before the due diligence process is complete. This includes looking over:

  • detailed financial statements showing income and expenses for the past three years, including tax returns, the breakdown of revenues and how they are generated (e.g. recurring and non-recurring) and other one-time forms of revenue that may or may not be available subsequent to the acquisition
  • a third-party verification of cash flow (revenue generation) from either the seller’s dealer or MGA
  • any liabilities the buyer may choose to acquire (e.g. an office lease)
  • a breakdown of the client list including demographics, how long they have been with the seller, the forms of revenue generated, products and services used and the size of their holdings and their reasons for dealing with the seller
  • a sample client file, complete with computer records
  • advertising records and referral sources
  • the seller’s complaint file, closed account sampling, lawsuits (pending or past history) and any judgments to which the seller has been subjected
  • the seller’s compliance and audit history. It is important to pay careful attention to any correspondence from the seller’s dealer or SRO for any actions taken or deficiencies noted.
  • identify the tangible and intangible aspects of the firm such as brands, market niches, seminar systems, client management programs, and other processes and systems that may bring increased value to the deal.
  • obtain a copy of all agreements including employment, property and equipment leases, and insurance agreements (property, errors and omissions, etc.)
  • any formal valuation undertaken by the seller
  • other contracts, leases, management reports (such as sales reports), a detailed list of client assets, employee organization charts, payroll and benefits records and marketing materials.
  • The process seems painstaking, but without it, the buyer won’t be able to accurately understand the pros and cons of purchasing a practice. And when it’s over, and buyers are ready to go ahead with the purchase and sale agreement, they’ll be able to do it with the proper perspective.

    Cindy Jenner Cowan is vice president of training and development at Worldsource Financial Management. With more than 17 years of experience in the financial services industry, the expert in relationship management and value-added coaching recently developed FRAMEWORKS, a training program for Worldsource advisors, focusing on advisory practice life cycles.

    Cindy Jenner Cowan