Due Diligence During the Pandemic

When you start to consider a deal, the seller hands over mountains of records and paperwork for you to review. But as a responsible investor, you need to go beyond that. Due diligence is defined as an investigation of a potential investment to confirm all facts. This process often includes reviewing all financial records, past company performance, plus anything else deemed material. Traditionally, it also involves a lot of face-to-face interaction, including site visits and facility tours. While the goal of due diligence has stayed the same, the process itself has been changing over the past several months.

How the due diligence process is changing

We’re keeping an eye on two material changes to the due diligence process.

First, due diligence needs to take place from a distance – whether that means sticking to deals within driving distance or outsourcing some aspect of the process – face-to-face time should be limited to avoid putting members of either team at risk. In a recent roundtable discussion, Axial pointed out that investors are increasingly kicking off the due diligence process with virtual meetings and video/virtual tours of sites are becoming commonplace. This requires a big leap of faith that what buyer is seeing on screen is accurate, so some teams are choosing to fly one person in confirm what they saw on video. The panel participants agreed that virtual tours could become much more common and could even happen earlier in the process as we get used to the new technology.

The second change to the due diligence process is that investors are interested in a deep understanding of how sellers are handling the pandemic. Harvard Law School recently published a list of new items that investors should be asking during the due diligence process:

– Is the seller compliant with laws related to COVID-19?

– Has the seller applied for or obtained any government assistance related to COVID-19? This may or may not include the CARES Act.

– How as COVID-19 affected the seller’s employees? What is the current state of the workforce? Have any key members of leadership been infected and how was that handled? Is the workforce able to work remotely or must they be physically present? What screening processes are in place? Smart sellers will already have a lot of this information readily available, but compliance should be investigated.

– Relatedly, how does all of this affect the seller’s real estate properties and any related contracts?

– How is the seller’s supply chain affected and being managed through the pandemic?

– How are the seller’s contracts performing at this time?

– How are the seller’s customers been affected during COVID-19?

– Does the seller hold any insurance that can cover COVID-19-related risk?

– Has the seller made any claims to date?

– How has the seller’s pension plan liability been affected by the current situation?

In addition, buyers need to examine representations and warranties insurance, as well as securities laws compliance, where appropriate. As always, buyers will need a deep understanding of the seller’s debt obligations. This is doubly true now.

Due diligence beyond COVID-19

As many mid-market companies have already realized, the due diligence process can be very expensive. Many organizations were already utilizing technology in more and more ways to save time and money, while still completing in-depth analysis. We expect those trends to continue even after a vaccine is identified.

For the next year or two, we also expect “How did you handle the pandemic?” to be a consistent question during the due diligence process. Leadership’s response to these uncertain times will tell potential buyers a lot about the seller’s organization.

If you are considering buying or selling a business, contact us for a confidential discussion of possibilities appropriate to your specific situation.