The following is adapted from Courage to Lose Sight of Shore.
Imagine you’re selling your house. You know there are rooms in need of a coat of paint, but overall,
it is in good shape. It should be the easiest sale in real estate history.
Then that first home inspection report comes through from a potential buyer and it is littered with
problems. Now you are in defensive mode, trying to put a value on each item in order to see the
transaction through.
Would it not have been nice to see that home inspection report before the buyer did — before you
even began attracting potential buyers? Instead of being blindsided, you would have been able to
correct the issues and control the narrative, which would help you yield a better price.
It’s the same when selling your company to a private equity firm. The buyer will perform a due
diligence that could unearth potential problems. It’s far better for you to do a reverse due
diligence on yourself to identify those issues ahead of time so that you can fix what you can and
position what you can’t.
The most important reason to perform the reverse due diligence is to gain insight into the current
state of your business and fix any potential deal breakers or issues that will significantly impact
the sale price, the number of potential buyers you attract, or the type of buyer you attract.
Any number of fixable problems could come up through reverse due diligence.
One of the biggest is whether your finances are above board. It cannot just be that you, the
founder, have been doing your books. Investors do not want to wade into messy waters like that. You
need to make sure you have an accountant who has shored them up.
A less obvious problem that comes up often during my work involves the ownership of intellectual
property rights. Especially in technology, founders sometimes contract consultants to advise them
(to build out critical infrastructure). If they failed to be explicit with the contract when they
had a product built out, there is a chance they do not fully own the intellectual property (commonly
referred to as simply “IP”).
Some firms might have expertise in this and be willing to work through it, but others may consider
it a deal-breaker. When you figure this out in advance, you can either fix the problem or allow
firms to self-select based on their willingness to address the issue.
Sometimes you have problems you just cannot fix, but you still must disclose them to potential
partners. Remember: if you don’t disclose them, the buyer will still find out anyway when they do
their own due diligence.
Author and CoolSys CEO, Adam Coffey, points out that doing your own research in advance allows you
to shape the story, giving you more control over your company’s narrative as you go on the market.
As long as you are aware of the issue, you can choose how you position it.
Coffey further says, “Don’t just look at the money private equity brings to the table. Money is not
operators. You want operators to help you.”
You already know there is something you need supported. Why else would you be seeking a private
equity partnership? Those things you can’t fix are exactly where a private equity firm’s expertise
can be beneficial. The better you understand your own limitations, the more likely you will be to
pick the right partner.
No one is expecting your company to be perfect, so lead with your problems. Private equity firms
want to hear about what you cannot do, and find out if it is something they can do for you. They’re
not afraid of getting their hands dirty, but they need to know how to support you.
Your weaknesses, properly positioned, may even be a key reason why they want you. For instance, what
you might consider a “weak marketing team,” they could consider an area for growth and therefore
return on investment. And maybe marketing is their specialty, making them a great match for your
company.
The key to a good private equity partnership is all about relationships. How you interact with the
buyer prior to a transaction is a litmus test for how you will engage post-transaction. Therefore,
you and your team should be genuine which illustrates the sort of partner you will be long term.
In the past, I have seen private equity firms walk away from deals because they got a feeling that
the people they were interacting with prior to the transaction were not being open or honest. In
every email, phone call, and meeting, they are assessing the people in front of them and asking
themselves, “Is this someone I can trust as we grow this company?”
In short, it is vitally important that you do not hide anything or misrepresent something that will
come out later. All that will do is undermine the deal.
By doing a reverse due diligence, you don’t need to hide anything. You can fix potential deal
breakers ahead of time and position any remaining issues in a way that helps to build a great
partnership.
For more advice on reverse due diligence and private equity partnerships, you can find Courage to Lose Sight of Shore on Amazon.
Kelley W. Powell is CEO and partner of MacLaurin Group, a company providing technology operating
partner services to portfolios of private equity companies. Supporting companies in growth and
M&A activities, Kelley brings a unique experience from founder-led organization to multiple
private equity-led cycles. Kelley is an avid mentor, angel investor, and chairwoman for the da
Vinci Center for Innovation Angels Advisory Board at VCU. She’s also a board member of the
Richmond chapter of the Association for Corporate Growth, and in 2020 was appointed by Governor
Northam to serve as a member of the Virginia Council on Women.