Merger and acquisition activity is heating up across the middle market. Moss Adams, which has middle-market clients in the western U.S., is seeing a continuous stream of M&A transactions within its client base. With those clients, two key themes keep coming up - opportunities arising at unexpected times, and few companies being prepared for the due diligence process.

This is particularly important in a hot M&A climate because success often means being prepared, in advance, to move through the deal process in an organized and timely fashion. Being ready and prepared for due diligence is often the pivotal factor in either moving forward, or coming to a full stop.

The owners of middle market companies are receiving a torrent of unsolicited inquiries about possible M&A deals. With the improvement in the economy and more predictable forecasts, owners are giving more attention to these inquiries. Some get cast aside, and some trigger a response. One thing I’ve learned is the best opportunity will often appear at an unexpected time.

Being prepared for this moment will create value for the owner, and will enable the buyer to properly evaluate the risks and reach a fair value. During the past year, we’ve seen transactions delayed for preventable reasons including:

Accounting and tax matters that unexpectedly emerge;

Inability to produce requested information and documents;

Appearance of undisclosed commitments and contracts;

Family personal activities comingled with the operating business;

Surprises discovered by the buyer that seller should have known about.

A buyer is seeking a detailed understanding of the value drivers, and requires confirming data that such attributes are recognized and sustainable. It’s not hard to know the value drivers. On the other hand, it is difficult to demonstrate these factors with organized financial information and data. This, not surprisingly, is where proper due diligence comes into play, giving both buyers and sellers a layer of confidence in the deal.

Ideally, the due diligence process should be a two-way street where the buyer gets an accurate assessment of the business and accounting practices of the seller, and the seller learns similar information about the buyer. As a starting point, a seller should understand the source of initial valuation for the business, in the form it will be transferred or sold:

The proxy for initial valuation is often a multiple of Ebitda;

The Ebitda should be calculated for the transferrable entity;

The Trailing Twelve Months (TTM) should be prepared monthly;

The owner should know the relevant comparables and multiples for the industry;

The balance sheet, and in particular working capital, should be normalized.

Surprisingly, many middle market businesses have not considered these initial points. It is more typical for an owner to read an article citing record-level EBITDA multiples for middle-market businesses, and then rest comfortably thinking this easily applies to his situation. Owners should know that rules of thumb are frequently referred to within the M&A market, but that such examples are not given any weight unless supported by data and confirming information.

Owners should perform mock due diligence on themselves. They should act like a buyer, and dig deeper than a company’s typical internal reporting. There are notable examples where owners have improved deal value by completing mock due diligence exercises to identify and correct deficiencies. In particular, with respect to tax planning, this is truly a case where the greater the lead-time, the more you can do to create value.

Today's market environment is becoming increasingly complicated, and it is important for both sellers and buyers to be prepared for detailed due diligence. Whether or not a company is for sale, readiness will protect and create value. Whether examining tax, business, or accounting issues, mock due diligence can uncover and investigate potential risks in advance of the opportunity when it someday arrives. A specialized due diligence team can help prepare a company for a transaction, even if a deal is not readily apparent on the horizon.


Harman Wales specializes in strategic and investment banking advisory services, and is a cofounder and managing director of Moss Adams Capital LLC.

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