In a recent TMR poll of readers, the topic of most immediate interest was “due diligence” and what it means for travel agents. This is a complex subject that I will discuss in a short series of articles.
The most common use of the term “due diligence” refers to the responsibilities of the buyer of a business. But it is also relevant in other circumstances, including the seller side of a buyout and important contract negotiations. Let’s take them up in order.
The concept boils down to a single idea, similar to “buyer beware.” It is the responsibility of the buyer to investigate the seller and the seller’s business before making a final commitment to buy. Failure to conduct proper due diligence leaves the buyer at risk for what he or she could have been discovered but didn’t.
The degree of due diligence required may vary somewhat with the scale and complexity of the transaction, but cutting corners on due diligence leaves the buyer exposed to post-transaction problems that can undermine the value of the entire deal. The buyer bears the risk of information he didn’t ask to see.
What then are the key elements of due diligence for the buyer? After a Letter of Intent is signed, the essential next step is an NDA, Non-Disclosure Agreement. In fact, the Letter of Intent itself should be considered highly confidential. The existence of the sale negotiation is nobody’s business but the parties to the deal. The NDA commits both parties to protecting, indefinitely in most cases, all confidential information learned during the due diligence and sale-closing. No seller in her right mind will provide confidential business information to the buyer without this detailed written commitment and no buyer should accept any information without it. This is a very important document that should be created by an attorney. Please do not try to do this on your own.
A savvy buyer generally will want to know every bit of meaningful information about the company before finally committing to buy it. The seller should be prepared to deliver all the requested documents on an agreed schedule. The buyer should be seriously concerned about what is being concealed if the seller resists relevant disclosures. The list of typical documents exchanged is too long to include here and in any case should be tailored to the transaction at hand. Using an agreement copied from a book or found on Google is taking a great risk. This is a job for your attorney.
It is highly likely that the buyer will want detailed compensation and job descriptions about agency employees. This is particularly sensitive and the utmost care must be taken to assure that this information is kept completely confidential.
Special care must also be taken when there is a “fire sale” scenario in which the agency is allegedly about to close unless a rush transaction can be completed. These situations may appear to create a bargain-purchase opportunity, but even so, agreeing to proceed without due diligence can lead to disaster. You likely wouldn’t buy a house without inspection or a car without test driving it. Why would you agree to buy a business without a firm grasp of its liabilities and other possible issues?
I mentioned at the outset that the due diligence principle applies to the seller’s interest as well. The reason is that the buyer may not be genuinely interested in buying the business. He may instead be scouting for information to use in competition with the seller. The buyer should not waste time working with an inauthentic buyer and a few due diligence inquiries may ferret out what the real motive is.
There are also cases when the buyer’s reach exceeds his grasp and he simply lacks the resources to complete the transaction. The seller should not waste valuable time and possible expense working with a buyer who can’t complete the deal. Conduct some due diligence inquiries of the buyer at the outset, focusing particularly on how the transaction will be financed.
In short, let caution be your watchword. Don’t make assumptions that cannot be supported by documents or other reliable evidence. Next month, we will explore some other circumstances in which due diligence is essential to business success.