The strategic importance of vendor due diligence in case of corporate acquisitions

Vendor due diligence (VDD) is a powerful tool that is increasingly becoming part of the acquisition process of companies. Not only in complex, international acquisitions, but also in smaller-scale local acquisitions. Whereas traditional due diligence is typically carried out by the buyer, it is the seller who initiates the VDD. In this process, an independent external party conducts a thorough investigation of the company in question. The aim is to give potential buyers confidence, by providing transparent and accurate information upfront. This benefits the parties on both sides of the table.

Vendor due diligence (VDD) differs from the traditional due diligence process in the fact that the vendor takes the lead in presenting its business in detail. An independent third party prepares an objective report for potential buyers, providing information on financial health, market position and potential risks associated with the acquisition of the company. This process avoids surprises, speeds up the transaction and builds trust between buyer and seller.

VDD offers a number of advantages for companies looking to stand out in a competitive market. The main strategic reasons why VDD adds value for vendors are as follows:

1. Supporting a strong negotiating position: thanks to VDD, the seller can identify and address potential risks early in the process. This strengthens its negotiating position by proactively acting on potential findings, rather than just reactively following identification by the counterparty. This allows you to spot and remedy, or better frame, any deal breakers early in the acquisition process. This applies to large, complex companies as well as less complicated corporate structures, where transparency is always a plus.

2. Speeding up the sales process: in any acquisition, time is an important factor. VDD helps sellers make essential information available in a timely manner, reducing the time and resources buyers need to invest in their own due diligence. Based on a well-prepared VDD report, buyers get a clear picture of the company structure, which shortens the exclusivity period and reduces the likelihood of buyers dropping out.

3. Management rehearsal: the management team gets a chance to practice and refine the sales pitch beforehand. The VDD process simulates buyers' questions and concerns, allowing management to prepare for sharp questions from the counterparty. This provides extra confidence and better preparation during actual presentations and management interviews. The result? Increased confidence of potential buyers in management as well as even more credible selling points, which can have a positive effect on the final transaction terms.

4. Maintaining the competitive process: especially in competitive bidding processes, VDD is a valuable tool. Potential buyers can participate directly and well-informed in the bidding process, keeping more parties involved and optimizing value for the seller.

5. Lower costs and greater efficiency for buyers: with an objective and detailed VDD report, buyers save on costs and time that would otherwise be spent on their own research. As a result, VDD lowers the threshold for buyers to step in. This increases the chances of a successful deal. For transactions with limited budgets, such as smaller companies, these cost savings can increase the attractiveness for buyers.

While the advantages of VDD are clear, a seller must also make some other considerations:

• Costs and scope of the due diligence report: Preparing a good VDD report is a time-intensive task, which also incurs costs. In addition, the scope of the report must be sufficiently broad to answer future buyer queries. Nevertheless, these costs usually outweigh the benefits of a faster and more reliable sale.
• Independent due diligence report: buyers must be convinced of the independence of the report. Therefore, it is important that due diligence is carried out by an objective, external consulting firm. This ensures that buyers have confidence in the information provided.

In Europe, where laws and regulations can differ significantly between countries and companies often operate within multinational structures, VDD plays a crucial role. Companies with operations in multiple countries must comply with complex tax and legal regulations. VDD provides potential buyers with a clear picture of this compliance and creates confidence among buyers, who waste less time identifying international risks. Moreover, the wider acceptance of VDD means European buyers and investors are often familiar with this tool, making it common to use these reports as a basis for negotiation.

In addition, in Europe, it is often important for selling family-owned and medium-sized companies to make the sales process as smooth as possible without costly delays. Here, VDD offers a clear, structured process that encourages confidence and provides the company with a solid starting position when selling.

The following case studies illustrate the importance of a thorough VDD

• A customer made significant investments in new production facilities. As the acquisition price was determined based on historical results and the net financial position at the locked box date, these investments were not reflected in the acquisition price. During the VDD process, necessary adjustments and normalizations were made to create a pro forma representation of the impact on the financials and the final acquisition price.
• A client acquired a smaller competitor last year, with a significant part of the acquisition price structured as an earn-out. Under the VDD, this earn-out was identified and classified as a debt-like item to avoid any subsequent discussions, as this liability is not reflected in the accounts under Belgian GAAP.
• A company switched from a FIFO (First In, First Out) to LIFO (Last In, First Out) inventory valuation method during the current financial year. This had a material impact on both gross margin and stock value. As part of the VDD, necessary adjustments were made to reflect a consistent inventory valuation policy, including quantifying the impact of the change on EBITDA.

VDD is a valuable tool that is increasingly becoming standard practice in takeovers within Europe. By providing transparency and bringing a higher level of structure to the sales process, VDD strengthens the seller's negotiating position, increases the likelihood of an optimal price and reduces the time needed for a successful transaction. Regardless of the complexity of the transaction, VDD helps creating clarity and trust, making the sales process more effective and efficient for all parties involved.