GovCon Mergers & Acquisitions: Eight Steps to Prepare for Legal Due Diligence
If you own or run a government contracting business and are looking at the possibility of selling in the
coming months or years, then you may already be worried about all the things you need to do to prepare. There are countless articles about ways to maximize valuation by cutting costs, focusing on key customers, and presenting your financial reports in the most positive light. But as much as presenting
an ideal financial picture may increase the potential purchase price of your businesses, having disorganized and incomplete records for buyers (and their lawyers) to review can undermine even the best financial projections. Most of these articles will suggest that you perform “due diligence” on your own business, but they don’t really tell you what that means. It remains some sort of time-consuming mysterious ritual performed with the help of overworked executives and expensive lawyers. While that may be mostly true, here are some practical tips on what you can do to get started.
Despite a year of uncertainty in capital markets and declining deal volume in the world of mergers and acquisitions, history would suggest that activity for small- and mid-market government contractors isn’t as susceptible to overall market conditions as the mega-deals that dominated the news in 2021 and early 2022. But we will likely expect to see more of a “buyer’s market” than what we have experienced in the last couple of years. So, what are the business equivalents of fixing the roof, replacing the worn carpets, and putting in a new master bath in order to attract more selective buyers and induce them to give you the best price in the sale of your company?
Unless your company has faced the rigorous sort of scrutiny that comes with taking on outside equity investors or borrowing from a bank, chances are you haven’t had to go through anything as invasive and time-consuming as “due diligence.” Gathering and organizing hundreds of documents and reports about every aspect of your business is a time-consuming (and, quite frankly, boring) exercise. However, it’s critical and necessary, all the same. Information about every aspect of your business needs to be shared with potential buyers. The topics include shareholders, employees, intellectual property, customers, financial reports, insurance policies, employee benefit plans, compliance programs, office leases, loan documents, lawsuits, and even lists of office equipment and inventory.
As you can imagine, gathering all of this information will take time and many of the same people responsible for gathering this information (your CEO, COO, CFO, accountants, lawyers, etc.) will be the same people involved in working on the sale process – which are the same ones trying to run the company!
So, what can you, as the owner or key executive of a company contemplating a sale process in the near (or not-so-near) future do to make this process easier? Follow these eight steps, starting today if possible.
Doing Your Due Diligence
Get your hands on a due diligence request for an acquisition deal. Stock purchase, asset
purchase, or merger, it doesn’t really matter (for this purpose). Get one from your lawyer. Get one
from a friend. Find one on the internet. Resist the temptation to find the shortest one you can
find and, if possible, find one focused on the acquisition of a business in your sector. Diligence
requests for government contractors, for instance, have entire sections devoted to specific
issues for these businesses.
Item Two:Review the list. All ten to twenty pages of it. Be advised, this might not be fun. As soon as you are done, put it aside, and then read it again. Make sure you understand what is being asked for, and hopefully why. Resist the urge to glaze over stuff that may seem meaningless or not applicable to your company. If you have questions, ask some of the advisors on your deal team that all of the other articles recommend you set up. The 8(a) program is designed to be a stepping stone for government contractors to help them build their past performance and understand the federal contracting ecosystem. Once certified, it is up to you and your team to build a favorable past performance. Because once the 8(a) certification goes away, a lot of the work you won will no longer be eligible for you.
Take the list and start tracking down every document that is responsive to the requests in the list. Use as many members of your team as possible. Annotate the list with your responses. If you aren’t sure which category is the better fit for something, put it in both. If you aren’t sure if something belongs, add it and note your questions for later.
Set up a data room. If you have hired an investment banker, they will probably be providing this service to you. Some lawyers will as well. There are also lots of programs and services that can you help do this, that fit into a variety of budget sizes. If you don’t have a banker or aren’t ready to pay for a service, then set up a folder in your (secure) work computer or a secure portion of your network and password-protect it. Then, set up subfolders for each grouping on the list and then additional subfolders for each item in each grouping. Name them with the same names (and numbers) in the diligence request list. Remember: you can always renumber or reorganize these later based on the actual request you get from the buyer’s lawyers, but if you have done this, then you are already way ahead of the game.
Start populating your data room with the documents you have identified. It’s OK if some
(or even most) of the folders are empty. A few will remain empty because you have nothing
responsive to the specific query. For example, if you don’t have any patents, then an empty
folder with no patents is what you will be left with. Be particularly careful with sensitive
material. Security clearance requirements, sensitive customer or pricing information, and trade
secrets, are some examples of things you will want to have access but may want to keep
separate from the other files to reduce the chance of unintentional disclosure. But DO make
sure you are gathering those materials and recording them somewhere so you can put your
hands on them when the time comes with minimal effort.
Identify what is still missing.
For the missing items that you know exist, start reaching out to key third parties to gather them. This could include customers, bankers, accountants, and lawyers. Note: gathering them in a non-emergency fashion is always preferable and is less likely to raise questions or prompt concern from nosy people.
If there are still missing items that you know (or fear) should exist, you are now in the
“fix the problems” portion of our exercise. This is your chance to fill in the blanks and clean up
your data room. For instance, perhaps you didn’t get some key employee document signed (or
even drafted), you didn’t revise your employee handbook, or you hadn’t got around to preparing a capitalization table to reflect ownership of company stock and options. Maybe it was something that you have been “meaning to do” for some time. Maybe it’s something you never even thought about. Creating this helpful “to-do list” will allow you to get these matters cleaned up without rushing around at the last minute and presenting them to buyers with the ink still wet on the documents – or even worse, trying to explain why these items don’t exist.
In the entire history of deal-making, we doubt there has ever been more than a handful of private
companies that were ready for due diligence without at least some “clean-up.” So, to give that great first
impression, have your corporate records complete, organized, and ready for due diligence.