Due Diligence in M&A Transactions: Why First-Time Buyers Should Avoid Analysis Paralysis
Due diligence is the process a buyer uses to verify a seller's claims, assess risk, and determine the true value of a business before a deal closes. It covers the financial, legal, and operational sides of the business. For a first-time buyer, it can be overwhelming, and the urge to investigate every possible risk can stall a deal until it falls apart.
That's an ExitReadiness® issue for owners whose growth or exit strategy involves acquisitions, whether it's adding a bolt-on business or buying a company to run. Deals depend on momentum. When diligence drags on, valuations shift, exclusivity expires, other buyers appear, and costs climb. Knowing how much diligence is enough, and which risks really matter, is what turns a promising acquisition into a closed deal.
In this episode, Pat Ennis and Corby Megorden talk with Michael Mercurio, an M&A attorney and principal at Offit Kurman, about due diligence from both sides of the table. Mike explains what the process involves, what first-time buyers consistently get wrong, and how to stay focused on the risks that truly matter without getting lost in the ones that don't.
Key Takeaways
Diligence has three buckets. Financial, legal, and operational. Financial usually leads; the heavy lifting begins after the letter of intent, with an intense first couple of weeks and updates continuing until closing.
Broad questions are intentional. A buyer's long checklist may seem excessive, but every answer, even "not applicable," tells the buyer something about the business.
Deals need momentum. Most deals should take 45 to 90 days. When they stop and start, the value proposition can slip away, exclusivity can lapse, and legal fees keep adding up.
You can't eliminate risk. First-time buyers often try to run every risk to the ground. The goal is to understand and manage risk, not erase it.
Don't overreach on your first offer. Buyers who start with aggressive valuations and then back off lose credibility with the seller and end up playing catch-up.
Risk tolerance is personal. Good advisors learn your objectives and risk profile, then tell you whether an issue is a deal killer or a manageable risk.
Use deal tools to bridge gaps. Representations and warranties, disclosure schedules, special indemnities, holdbacks, escrows, earnouts, and set-off provisions let you move forward while protecting yourself.
The wrong advisors cause trouble either way. Inexperienced advisors may miss real problems, or over-lawyer the deal until it dies. Choose people who do M&A regularly and know what's market.
Where to Start: Mike's Three Steps for First-Time Buyers
Hire experienced advisors. M&A isn't inexpensive. Choose attorneys and financial advisors who have done many deals, not ones doing their first.
Line up your financing first. Know whether you're using personal resources, investors, or a bank before you make an offer. Coming up short later costs you credibility.
Know what you want. Define clear objectives and share them with your advisors, so they can filter out the noise and keep the deal moving.
About Michael Mercurio
Michael N. Mercurio, Esq., is a principal at Offit Kurman and chair of its Business Law & Transactions Practice Group, based in the Washington, DC, area. He serves as a strategic advisor to entrepreneurs, closely held companies, and family businesses on business formation, structure, financing, and capital, and a significant part of his practice focuses on mergers and acquisitions on both the sell side and the buy side. He has negotiated dozens of transactions representing hundreds of millions of dollars and has repeatedly been recognized among the Best Lawyers in America.
Connect with Michael: offitkurman.com/michael-mercurio
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Disclaimer: The information presented in this podcast is provided for educational purposes only. Neither the presenters nor ENNIS Legacy Partners are engaged to render legal, accounting, tax, or other professional services. Consult a qualified professional regarding your specific circumstances. ENNIS Legacy Partners assumes no legal liability for any loss related to information contained in this presentation.
Full Episode Transcript
This transcript was generated automatically and lightly edited for readability. It may contain minor errors.
Hey there, this is Pat Ennis of ENNIS Legacy Partners. Welcome to the ExitReadiness® PODCAST. I'm here today with business partner Corby Megorden. Our mission here on the podcast is to provide you, the business owner, with subject matter expertise on topics pertaining to building transferable or sellable business value and then for planning your eventual exit from the business. We want to help you build a business that is transferable and then exit successfully on your own terms and conditions.
Due diligence is an often-mentioned topic on this podcast. Due diligence is the process in which a potential buyer takes a deep dive to verify the seller's claims about their business, with the purpose of assessing risk and determining the true value of the business before a transaction is finalized. It's comprehensive. It includes examining the financial, legal, and operational aspects of the business to ensure everything inside is as it appears, or as it's being represented by the owner or owners. Most of the time on the podcast, we're speaking to owners who are thinking of selling, about what they should expect and prepare for in due diligence.
But today we're going to address buyers. Perhaps you're in that mode: your growth and exit strategy actually involves acquisitions, and so you're going to be the one doing the due diligence. And perhaps it's going to be the first time you do it. Maybe you haven't bought a business before. So that's what we're going to discuss today. Our topic is Due Diligence in M&A Transactions: Why First-Time Buyers Should Avoid Analysis Paralysis.
And our guest today is our friend Mike Mercurio. He's an attorney and principal at the law firm of Offit Kurman, based here in the Washington, DC, area. Mike is a strategic advisor and partner to entrepreneurs, closely held enterprises, and family operations on really all aspects of the business. He has extensive experience in business formation, structure, financing, and capital, and a significant portion of his practice focuses on mergers and acquisitions, advising clients on both the sell side and the buy side. He's designed and negotiated dozens and dozens of mergers and transactions representing hundreds of millions of dollars.
He's repeatedly been listed as one of the Best Lawyers in America, and he's very well known and highly regarded here in the Washington, DC, and Baltimore area. Mike, as always, good to see you. Welcome to the podcast. Great to have you with us today. Thank you, Pat, for the kind words, and thank you, Corby, as well for hosting me. It's my pleasure, of course.
Good. So Mike, let's get started with a high-level overview of what a due diligence process typically involves, for either a buyer or a seller. What are the big categories of what's looked at? And second, how long, from your perspective, should it take in an ideal world? Gotcha. Well, thank you again for hosting me. Diligence is an important topic, and I know you talk to lots of sellers, most of whom aren't prepared for it.
They've never had their businesses looked at in this depth and magnitude, except maybe if they had some bank financing; banks will look to a degree. You referenced it in your opening remarks: diligence typically falls into three buckets. There's legal, there's operational, and there's financial. Financial typically is the lead dog. Buyers typically ask for financial data on the target, generally limited to a couple of years of financials and tax returns and the like, and that gives them an idea of whether the business is even of any interest.
But assuming it is and it gets to an LOI, now comes the real heavy lifting. Your typical buyer is going to send over a very significant list of due diligence items, many, many pages long, that they want to see: copies of a lot of really deep-seated items that you, as a seller, probably hadn't thought about, and that you may think are way beyond the scope or not applicable. There's a method to the madness. A buyer wants to take a very broad brush to its inquiries, and it's going to ask things that may seem outlandish or beyond the scope, but that's intentional, because when you're doing diligence, you're learning about your target.
Every answer, whether it's a yes, a no, or a not-applicable, gives information, and that's by design. Diligence starts in earnest right after the signing of an LOI, and it typically continues on, so sellers should be aware that there are obligations to keep updating diligence up until closing. But the concentrated period is usually the first two weeks or so. Typically it's done electronically, through a data room. From the legal perspective, we're looking for documentation: we give you the due diligence checklist, and we want documentation.
Financial documentation as well, which is generally handled by the financial people, and operational diligence means coming on site. Diligence is very, very important. I always tell sellers that you've run your business not in a vacuum, but in an air of confidentiality and maybe secrecy, and now you're opening up your business. Diligence is your friend. You want to be open.
You want to tell the other side all the good things, the bad things, and the not-so-good things that may be part of your business. And if they're not so good, run them by your counsel first. But you've got to disclose fully and completely. Excellent. Okay. So now let's shift to the buyer and the analysis paralysis in our topic today. Corby, I know you've got a question.
Yeah. Corby, what's your question? Yeah, Mike, you did a blog post the other day on first-time buyers in particular and analysis paralysis, and you referred to unnecessary minutiae. Unpack that thread. Yeah. M&A is complicated. On the sell side, for most sellers it's their first time, and it can be daunting and overwhelming. The same holds true for first-time buyers, right?
I always say that on the sell side your job is "easy," and I say that in quotes, obviously tongue in cheek. You've got to know what you're getting: hopefully you're getting some money, and you know when and how you're getting it. That's number one. And you want to know what you're looking over your shoulder for, in terms of trailing liabilities. That's easy. But on the buy side, if you're a first-time buyer, you haven't been through this.
Now you're trying to figure out how to evaluate this target, what valuation and price to offer, and what terms should go with it. And how do I get to know this target so that when I take on this business, one, I'm getting what I think I'm getting, and two, I'm getting it for the value I think I'm paying, and I'm not going to be blindsided by some liability or issue that comes up that I missed or that wasn't disclosed to me? Like everything in life, nothing's black and white; it's nuanced. To take a step back, M&A has timing considerations. Deals have to have momentum.
The best deals have momentum and a cadence. When deals start and stop, they lose momentum, and when you lose momentum, bad things happen. My experience with first-time buyers is that they really struggle with getting it right in terms of how much diligence to do, when to stop, and when to rely on their lawyer to say, "Tell me about this risk. Let's try to quantify it. How substantial is it?" Meanwhile, the days turn into weeks, the weeks turn into months, and you may lose your value proposition because of your hesitancy to move forward when you can't quite get a handle on the risks. And we live in a world of risk. You can never eliminate risk; it's built into the DNA of running a business.
Yeah. So are there common causes for the paralysis that you see? Yeah. One is on the financial side. This year especially, we've seen a lot of paralysis, or stopping and starting, in the markets because of the financial metrics. I don't profess that it's easy to value a business and figure out where it's going over the next so many years, especially in the Washington, DC, marketplace. All the things everybody knows about, right? The government shutdown, tariffs, this and that.
So it's not an easy go. The challenge is that, for most of these businesses, buyers are going to do a quality of earnings, which gives them a report that kicks the tires hard on the earnings, the earning potential, and the quality of the cash flow. And if you can't get your arms around it, you may go down a rabbit hole. Again, the days turn into weeks, and the weeks turn into months. Then you get the banks involved, because many first-time buyers don't come with enough capital to satisfy the deal.
So they have to get a bank involved, and that's another inflection point: a financial institution doing diligence. To give you more context, you get an LOI. You started with some preliminary financial diligence, and whatever you did, you came up with a price, a valuation, and some preliminary terms. Okay, great. Now you've got to go out and validate those things while you're doing your other diligence and trying to advance purchase agreements.
You go out and get a quality of earnings, which may take some time, and it almost always comes back with "Yeah, maybe it's good, but you should think about this." Then you go to the bank, and the bank says, "Yeah, we could do these terms, but you should consider this." All of that goes back into the bucket, and now you're tweaking LOIs and going back to the start. So you're going in circles. Some of it is necessary and required; if a business isn't meeting expectations, a buyer certainly has a right to change its terms. But you can go too far.
And in my experience, first-time buyers, when they don't have the experience and don't know the market, struggle immensely, and the deals drag out. When do you see them go too far in this area? Well, at some point it's a yes or no whether you're going to move forward with an acquisition. There's often a mismatch in valuation expectations between buyer and seller, and I think buyers go too aggressive with their initial valuations or initial terms, and then they have to back off. When they do that, it sends a message, and they can never catch up.
They can't catch up, because they're always chasing. Once you tell a seller, "This is what you can expect; this is what I think your business is worth," it's really hard to go back. So you're always playing catch-up, and that's a challenge. The financial side has been a big challenge in this marketplace, but it's not just the financial side. It could be legal, employment issues, or tax issues.
More and more business owners are doing business in multiple jurisdictions because of remote work, so now you start running into sales tax and state and local tax issues and the like, and that can get very complicated. In the end, I think what it comes down to is that you need to hire good advisors. Sometimes first-time buyers try to do things on the cheap. There are a lot of different types of buyers, right? But think about a company that's growing: you're an entrepreneur, you want to grow your business, and you want to take on a bolt-on, but you've never done it before.
So now you're trying to figure out how to take on this other company, and which risks you do and don't want to take. You can't just run every risk into the ground and eliminate it. You really have to take the advice of advisors. They may tell you it's not a good risk to take on, or they may tell you it's a very manageable risk. But I find that first-time buyers especially, though not exclusively, struggle. They have a hard time quantifying risk, or think they should quantify it, and you just can't eliminate it.
Yeah. So what kind of help are they going to need to prevent that from happening? Well, first of all, they have to hire good advisors. M&A is specialized, whether you're on the sell side or the buy side. People who don't do deals regularly, or haven't had enough experience and exposure, don't know what's market, or what's commonly found out there, what typically comes up, and how to mitigate it. So hire a good lawyer and good financial people who can not only kick the tires on the finances and get you valuations that are as solid as you can get, but also offer terms and potential solutions for bridging gaps, with earnouts, holdbacks, escrows, and the like.
That's where it starts. You've probably seen clients struggle: if they don't have experience doing it themselves and they don't have good advisors, it's a really tough road, and somebody's potentially going to lose. Yeah. Go ahead, Corby. Yeah, Mike, what comes to mind is that you mentioned quantifying risk. The accounting concept of materiality comes into play.
How does a buyer assess materiality, and then how does that move into minutiae? Well, first of all, everybody's risk profile is different. That's the important thing to understand. My risk profile and risk tolerance are different from yours, and maybe different from the next person's. So if you're an advisor, the first thing you need to do is understand your client's risk profile, their tolerance, and their objectives, so you can use that as your map going forward.
But you're right, materiality is important, and the only way to know what's material and what's likely to happen is to hire advisors who have been there and done that, who can tell you, "I've seen this situation multiple times; this is how it's likely to play out." I always tell clients, "This is your deal. My job is to tell you what I think the risks and issues are, and your job is to tell me whether you care about them or not." And sometimes, in my profession, lawyers are part of the problem, because they don't understand what's market. They haven't seen these things enough times, so they say, "I have to drill this down to the minutiae," whatever the minutiae are. They drill it down, and they're deal killers.
You just can't get to a place where it's reasonable, by market standards, to move forward. Some lawyers can be accused of that. They over-negotiate things and become obstacles rather than centers for getting deals done. That happens, unfortunately. It shouldn't, but it does. Yeah. I know you've probably run into those lawyers, and they're not good lawyers in that respect; they don't listen to their clients.
Yeah. On a related note, I'm a financial analyst, and I've seen diligence where the focus of the financial analysis seems to be on typical accounting, as opposed to managerial accounting, meaning what's germane to the operations of the business. Do you see that? Yeah, I see that. I also see that there are some people in the financial space, and they say lawyers do this too, though I don't subscribe to the idea, who think their job is to find problems: okay, I've drawn you into deep water, I've offered you this price, and now we're going to do our diligence and everything we can to figure out how to knock the price down, how to avoid paying you cash up front, how to change the valuation, how to handcuff you in all different ways. The gotcha mentality.
I don't subscribe to that, but I see it often. When I'm representing sellers, I say, "Listen, when you get an LOI, it might be your high-water mark. This could be your best day, because if they find your business is better than they thought, they're never going up, but you can believe that if they find a challenge, they're going to change the terms." That's their right, of course. But yes, I do see that. We're lawyers, and while we're versed in numbers and so forth, we defer the financial diligence and analysis to the financial professionals.
There's a team approach to diligence. We do the legal part, and the financial folks crunch the numbers, and maybe you do that too. It's an art, right? Everybody will tell you there's subjectivity to the value of a business, and professionals can disagree. Yeah. What comes to mind is that I'm a forecaster as well, and forecasting is an educated guess.
But people buy the future. So I think buyers need to grasp that nobody can guarantee the future. It comes down to risk tolerance and probability, and whether they line up. 100%. Right. We live in a world where many of us like to control and know everything, and we can know a lot of things, but you just can't know it all. It's a guess. You just don't know where the business is going to go.
And the longer you drag things out, the more likely something is going to change. For a seller, we say you've got to get the deal done as quickly as you can, because of confidentiality and all kinds of things. For a buyer, the longer you drag it out, the more likely something will change: the market, the valuation, or the target. Your exclusivity will expire. Deals are about leverage, right?
If you're a seller, you try to build up leverage by finding multiple suitors. If you don't have your act together as a buyer and you let your exclusivity lapse, there are other people out there. You might have done all this work for naught; they move on without you, and now you've got costs. So unlike most things in our world, you can't know everything, as much as we try to control all the variables. You have to hire good advisors and rely on them.
Diligence just helps you manage risk. We haven't talked about this, but besides doing diligence, you write agreements with representations and warranties. You've probably seen them; they're very in-depth. Buyers ask for all kinds of detailed reps, warranties, and covenants from sellers, and for disclosure schedules that set out in writing the things we're asking you to verify: your employees, the states you do business in, your major customers, and a whole host of other things. When you put all of these together, that's how you manage your risk.
You see the story through conversations, review of documentation, and your advisors' reports, and once you've put it together, you figure out where to go. But if you sit on it too long, you might lose your opportunity. Yeah. So say you're a first-time buyer, and you have a professional on your side of the table helping you negotiate through the process, but they don't have a lot of deal experience. They've done a few deals, but maybe they mostly do real estate transactions, or wills, or whatever.
What kind of trouble can you get into, particularly related to this analysis paralysis? Well, the first thing is that if you don't have qualified advisors, there's a real risk that you'll miss something and end up with a real problem, because your advisors didn't do enough diligence. So I'll take your question the other way for a second. If you don't have the right advisors, people who have done this and are subject matter experts, you'll miss things. M&A is what it is, but I have to bring in subject matter experts, partners of mine, to review taxes, benefits, employment, intellectual property, and the like.
If you don't do those things, and I'm not saying over-lawyer it as a buyer, you might miss something, and if you do, it's going to be your problem. That being said, if you have the wrong law firm, one that doesn't do this for a living, or lawyers who are obstructionists, who block you every which way, saying, "I can't let you do this; we have to ask more questions," you just run out of time. In the end, it's a business deal, and legal is one step; it can't drive the full transaction. You're never going to get to the point where you know with certainty that this is the way it's going to be. So there are two ends of the spectrum.
You don't want to be so cursory, quick, and cavalier with your diligence that you don't ask the right questions. But you also don't want to be so in-depth that you hammer the same things over and over because you don't really understand the risk, you don't understand your client's risk profile, and you don't have enough experience to say, "Okay, we have an issue here. Let's write a special indemnification, hold back some money, or re-evaluate how we're paying," or whatever it may be. There are a lot of ways to get from point A to point B. Some firms deploy only one way, and some people only know one way. Is it the best way? Sometimes, but not always.
You have to be flexible and fluid. It's part of entrepreneurship: you take calculated, informed risks, and hopefully your lawyer is informing you, saying, "There's a little bit of hair on this, but is it a deal killer? No. We'll box it up. We'll ask them to rep to it, hold back some money, or put a set-off provision in the promissory note," whatever it may be. Or maybe there are multiple things. All right. In the last couple of minutes, give listeners who are in buying mode three things they need to think about.
Okay, sure. Number one, I'll give a plug: hire a good attorney and good advisors. I always tell clients M&A is not inexpensive. It's just not. People ask, "What's it going to cost?" That's hard to say, but I'll tell you this: it's not inexpensive. So go to a firm and find advisors who have been there themselves. Don't hire someone who's doing their first deal while you're doing your first deal; that's no good.
Second, figure out your finances in advance. Know whether you have the personal resources, investors lined up, or a bank in place. The worst thing is not having those in place and then trying to get them while the deal drags out. You say, "I'm going to offer you $10 million," and then, "Oh, the bank will only give me $5 million." You just lose credibility. And the last thing I'll say is, know what you want.
Have clearly defined objectives, and communicate them to your advisors. You can be pulled all over the place, so know what's important to you and block out the noise. We advisors work for the client, and if the client doesn't know what they want, it's really hard to give them good advice, and you risk getting into this area of paralysis, going around and around. I've had some deals this year where we started and stopped and started and stopped. You guys do deals: they should take 45 days, 60 days, maybe 90 at the most, or 30 if you're really quick, but deals are now taking six or nine months.
All that causes a lot of frustration and a lot of stops and starts, and it costs a lot more money than it needs to, because remember, your advisors, at least the lawyers, bill by the hour. Every time we start and stop, resources dissipate pretty quickly. If you don't have momentum driving to a conclusion, at minimum you're inefficient, and at maximum you might miss something and pay a fortune. So those are the three things I'd offer, right off the top of my head. Fantastic. Okay.
Hey, anything you want to promote today? Are you writing a new book? No, though I need to write a book; I'd like to. I'm pretty active on LinkedIn, writing a lot about M&A and the M&A process, and I'm developing my own podcast on M&A, but it's not there yet, so there's nothing in particular to announce. It's just my pleasure to talk with you about M&A. First-time buyers do struggle, and everyone's got to start somewhere, so it's by no means a criticism.
Entrepreneurship is what drives our country. But it is an observation, and one I've seen more times than I'd like. With first-time buyers, you always kind of cringe a little bit. Fantastic. So if someone wants to contact you, Mike, they can just go to LinkedIn? They can go to LinkedIn, or to our website, offitkurman.com, where you can find me.
I can give you my email address and phone number, if that's appropriate. Sure. Okay. My email is my first initial and my last name, mmercurio, M-E-R-C-U-R-I-O, at offitkurman.com. And I'll put out my cell phone: it's 410-916-3625. I tell clients, listen, your lawyer needs to be accessible to you. Deals have timing, so I don't mind if people call me on my cell phone. Excellent. That's very good. Thank you, Mike.
Hey, thank you both. I really appreciate your time and interest; it was a great conversation. It's always a pleasure. And listeners, if you want help maximizing the value, transferability, and sellability of your business, or planning for that eventual exit, whether it's a sale to a third party, where there's going to be a transaction like we've been discussing today, or an internal transaction, an ESOP, whatever; or if you don't know what you want to do about an exit and need help figuring out what you want, which is what Mike just said a few minutes ago, get in touch with us. You can do that through ennislp.com or exitreadiness.com.
And thanks for listening. If you've benefited from today's episode, and I know you have, please consider liking it and sharing it on social media. And until next time on the ExitReadiness® PODCAST, this is Pat Ennis and Corby Megorden signing off.
