An Insight into Reverse Due Diligence
“Due Diligence“ usually describes an exercise wherein a potential investor undertakes a series of examinations to evaluate the financial and operational health of the investee company and compliance levels before investing. But what if the management of the investee company is a step ahead? It will provide a critical, introspective look at their own company, predict the requests likely to be made by an investor, and proceed to assess the company’s operations similarly. It will minimise the element of surprise and enable the company to be ready with all the answers and make value-enhancing adjustments along the way.
This is indeed what “reverse due diligence is- being proactive and taking a step back to look at the operations and financial health of the company and evaluate, correct, or improve what the investors will see before they conduct their due diligence.
What Does Reverse Due Diligence Entail?
Reverse due diligence involves the similar steps as are associated with due diligence got conducted by the investor as that’s precisely the objective, to do it before the investor can and in the same manner as if they were representing a prospective investor assessing the company from an investment target. The only difference is that it would be from the viewpoint of the investee company to increase the efficiency of the business to make it attractive to potential investors.
It encompasses the following kinds of due diligence:
- Financial Due Diligence: It involves analysing the level and growth of the company’s financials. This includes assessing the company’s earnings, cash flow, balance sheet, and working capital requirements, evaluating the expense level, whether the profits could have been higher, and indebtedness, among others.
- Business Due Diligence: It includes assessing the main business of the company, its positioning in the market, whether it can tap other markets, competitors of the company, and its customer base.
- Legal Due Diligence: It involves evaluating whether there are any pending litigations by and against the company, their progress and their impact on reaching their finality, the level of compliance of the company under various laws applicable to it and whether there are correct internal controls and systems in place to ensure compliance.
How Does a Company Perform Reverse Due Diligence?
The investee company could either engage its internal audit/compliance team or other employees or use external consultants and specialists to perform due diligence on its business. The due diligence report would present findings and recommendations the investee company can act upon and give a blueprint on the corrective measure that may be required to be taken and the amount of investment required to be obtained.
Benefits of Conducting Reverse Due Diligence
1. It sheds light on the value of the company.
Conducting reverse due diligence will give the investee company an outsider’s view of the business and help in knowing its value. While this could be a double-edged sword wherein the results produced will either significantly increase the value or will emerge at a lower value, it could reduce the investor’s negotiating power and ease the transaction process.
2. It lessens unwelcome surprises.
Reverse due diligence enables the investor company to be in an advantageous position. Having knowledge about any unfavourable situation and being transparent about the same will go a long way in better negotiations with potential investors. The investee company will seem credible and trustworthy and will be in a better position to resolve the queries of investors comprehensively.
3. It enables implementing of corrective systems and processes.
Reverse due diligence will provide findings on any issues, breakdowns and deficiencies in the existing systems and business operations. The investee company can take corrective measures before the investor conducts due diligence.
4. It aids in deal structuring.
Conducting reverse due diligence would enable the investee company to arrive at an appropriate deal structure in terms of the amount of investment, securities to be issued, and exit methods to be negotiated with potential investors, among others suitable to meet the objective of the company.
5. It lessens the time for investor’s due diligence.
Engaging in reverse due diligence can help the investee company roll over its findings and documents into the investor’s due diligence and reduce the time investors take to conduct their examinations and finalise the deal and can facilitate a smoother transaction.
6. A continuous process.
The exercise of reserve due diligence should be a continuous process and not an one off exercise so that the company keeps updating and remains due diligence ready.
Act now! Investing in reverse due diligence would be an intelligent step, as doing so will help increase deal value and improve negotiations. The investee company can turn the tables around, prepare itself for potential risks, determine improvement areas, minimize uncertainty, and speed up the transaction process.
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