003: Due Diligence – Uncovering the Skeletons in Your Closet

Due diligence is a crucial and time-consuming component of any M&A transaction.

In this episode, Gina Cocking and Jeff Guylay discuss business due diligence. 

Due diligence is so important in any M&A transaction that we devote four episodes to the topic. In addition to business due diligence, we cover legal, accounting, and technology-related aspects of due diligence in episodes 004-006.

EP003: Business aspects of due diligence (today’s episode)
EP004: Legal aspects of due diligence 
EP005: Accounting aspects of due diligence
EP006: Technology aspects of due diligence 

The two key points from the discussion on business diligence in today’s episode:

1) Organization is crucial in this process; every document will be requested, every question will be asked.

2) Prepare so that there are no surprises; every rock will be overturned. 

Essentially, a seller needs to tell their advisors the good, the bad, and the ugly.

You’ll see why we’ve named this episode “Uncovering the Skeletons in Your Closet”.

This episode features guest Rob Humble to provide his insights from his involvement with transactions as both the buyer and seller. Rob is the Senior Vice President of Strategy and Corporate Development at IAS. 

In this episode, Gina and Jeff of Colonnade Advisors address the following questions:

What is due diligence? (02:18)

The process of working with the management of a company and, at a very high level, learning everything that possibly can be learned about the company. Colonnade Advisors turns over every rock to understand all of the strengths and weaknesses of the company, understanding both the past, present, and future. We understand why the company does certain things, what the contracts say, and what its obligations are. We do an assessment so that when the buyer or a lender comes in, they know what they’re getting into.

What is examined during due diligence? (02:48)

Employee records, contracts, financials, lawsuits, marketing plans, training manuals, handbooks, analyzing turnover, customer concentration, unit economics, etc. All the skeletons in the closet, everything about the business.

How does due diligence affect the Purchase Agreement? (04:41)

A large component of the purchase agreement is the reps and warranties section, where the seller represents that everything they have shown and shared with the buyer is true and correct, etc. The legal agreement, the purchase agreement, governs the transaction and the future.

What is a confidential information memorandum (CIM)? (6:20)

Jeff Guylay:  “When I think about the CIM, the confidential information memorandum, or the book, that’s really a mix of disclosure, risk, and market business and how great is this company and what are the future prospects… also what’s happened in the past and what are the risks for a future buyer, going forward.”

Who is involved in due diligence? (08:13)

Gina Cocking: “It’s handled by a number of people. If it’s a private equity firm, the private equity firm team members are very knowledgeable and will ask a lot of questions in the business diligence segment. There will also be consultants that are hired from time to time, specialized consultants that understand the industry or the specific product that’s being done, or sometimes they’re HR consultants or specific marketing-types consultants.”

What happens first in Colonnade’s due diligence process? (08:55)

Jeff: “When we get hired to work with a client, the first thing we do is put together a due diligence request list and a data (request) list. We get together with the company, and we spend the better part of a day, and sometimes a day and a half, going through our lists and just asking question after question after question.” 

What is the purpose of Colonnade’s due diligence? (09:35)

Jeff: “The point of us going through and asking all these questions is to put our investor hat on or our buyer hat on and ask 90% or 95% of the questions that they (the buyer and/or investor) are going to ask. We want to make sure that we have all the right answers…before they’re required by a buyer, and we want to make sure the story is consistent.”

What if there are skeletons in the closet? (10:10)

Jeff: “If there are any problems, let’s hear about it now, because the worst thing you want, as we’ve talked about, is to have surprises later on or something come up at the last minute that can kill a deal or have a major change in pricing or terms.”

Gina: “I’m your business confessor, for all the ugly and dirty and you-wanted-to-hide-it-under-the-bed (items; it’s) time to talk about it because it will come out later, and the worst thing is to not be prepared for when that happens, so we need to know everything.”

The advisor-client relationship is one of trust.

What are the first questions asked when kicking off Colonnade’s diligence session with a new client, and how do those questions add to the story? (12:49)

When and where was the company formed? What is the corporate history? What are the major operating entities? What are they doing, what’s the purpose of them? Is there any tail liability that we should be thinking about or carving out?

Why are these questions important in the due diligence process? (13:51)

Gina: “Everybody remembers a story. It’s great to hear the owner’s story because we often are retelling their story later on.”

Jeff: “When we launch into the market..we’re the front line of communications. We’re expected to be able to answer 90% or 95% of the initial questions that come through. We’re telling the story, and the (Colonnade) diligence process is meant to educate us, to make sure that we’re as fully informed about the history and the prospects of the company as possible.”

What are some of the legal aspects of the diligence process? (15:00)

Gina: “Not only do we have the different legal entities, but we also have different tax structures, sometimes they’re C-corps, sometimes they’re S-corps, and so you have all these different legal entities, all these different tax structures.”

Jeff: “This is usually where we request the name and contact information of the attorney. If you have ten entities and there is no holding company, we should probably do some leg work ahead of time and clean things up. I know we’ve done that on a number of deals.”

(Please note that the Middle Market Mergers & Acquisitions podcast will dedicate an entire aspect to the legal aspects of due diligence)

What kinds of documents are requested in the due diligence process? (18:16)

Gina:  “We’re going to ask for all the formation documents, operating agreements, shareholder agreements, articles of incorporation, the state articles of incorporation, that can be three or four documents per legal entity… “

Jeff (19:10): “In addition to the shareholder documentation, we’re looking for board minutes, board packages, (and) all the corporate organizational materials that have been accumulated throughout the years.”

What important business aspects tend to come up during the diligence process? (20:32)

Gina: “An important component of any transaction is customer concentration. That has a big impact on valuation, and there’s a very logical reason as to why. If a customer represents a lot of the company’s revenues, the buyer’s concern is, ‘Wow, what if that customer walks? What if you lose that customer?’ And then I just bought a company and it has 60% of the revenues that I thought it had. There are a number of PE firms… where their fund will say, ‘We cannot buy a company that has customer concentration of greater than 20% for one customer or 60% for the top three customers.”

Jeff: “The next topic we cover when we’re talking about revenue is the sales force, so sales and marketing in general. We get a good picture of what they’re selling and who they’re selling to, and now the question is how are they selling? Do you have a direct sales force? Is it a channel strategy? What are the different ways that this company goes to market, and how are they selling stuff?” 

What are some other questions that come up during business due diligence? (22:57)

Jeff: “How do you pay your sales force? What sort of non-solicitation or non-compete agreements do you have with your sales force?  How institutionalized are the relationships? How long have they been around?” 

Gina: “A (common) situation is when the buyer says, ‘I would like to speak to the end customer.’  We often get into discussions with the buyers about when those conversations will happen.”

Jeff: “The other thing I would comment on in sales and marketing is getting a sense of competitors, so what does the competitive landscape look like? (26:02): Part of the go-to-market discussion is how are you going to market against your competitors? So, what are they doing differently than you? How do you compete against them? And how are you going to win?” 

Gina: “The next area that we start looking into is marketing channels and marketing partners. Clients sometimes have a partnership where they are co-marketing with another entity. We get really excited about marketing partnerships. It’s not necessarily because there are a lot of sales coming through those channels, but because of the validation that they give to the company.”

Gina: “The other side of sales is the cost of goods sold. Who are your vendors? We’re going to look into all of your vendor relationships . . . We will take a look at the pricing from the vendors. We’ll be looking at the contract terms with the vendors.” 

Gina invites Rob Humble, Senior Vice President of Strategy and Corporate Development at IAS, who shares his perspectives from both the buy and sell sides as related to business due diligence.

Gina: “How do you stay organized and keep the process moving quickly?” (32:10)

Rob: “It’s definitely like herding cats.  Upwards of 100 people, between advisors and internal folks. I believe, fundamentally, that time kills deals; so you have to be as efficient as possible.”

It really comes down to two fundamental points in the process:
1) Preparation (Pre-game)
2) Truly committing to the sale process (Game on)

“(Pre-game) we literally took our own medicine, and it took us a few months of answering our own questions before we had a data room that we felt was full. You can be much more strategic about the way that you present (the information) in your sales material, and you can also be more strategic about the rate and timing of when you release those documents. We used the diligence checklist that we use for the buying process…for creating our own internal data room.”

Gina: “I think one of the biggest problems that companies run into is trying to stay the course and do their day job (running the business) while going through a sale process without all the wheels falling off the bus.” (34:00)

Rob: “There are three components (to our success) that come to mind:

1) Designate a leader of the process. The best person for this is that utility player that is great at coordinating across the team and ensuring the organization is really given the attention that it deserves. You need a utility player that knows the organization, knows the people, knows the data, knows the system, and can run point for you.

2) Form a team that meets every week. That’s a cross-functional team with the players that have access to the data systems and decision-making authority that you need to answer questions and have them be supported by the evidence that will ultimately get dug up in later diligence. 

3) Follow a clear process. We were very careful.

Gina:  “You did quite a few acquisitions over the last four or five years. But you were also involved in the sale of IAS. How did it feel to be in the hot seat? I mean, the tables were turned.” (39:00)

Rob: “I loved it.  A sales process, at the end of the day, is just telling a story and supporting that story with evidence to make it as believable and credible as you possibly can. I loved the process of understanding what our story is, building the dataset to support that story, and then going out and telling the story.” 

Gina: “Now, looking back on all that you’ve done, is there one piece of advice you would give to someone that is getting ready to go through an M&A process?” (40:07)

Rob: “Get the right advisors.” 

About Our Guest

Rob Humble leads strategy and corporate development for IAS. Before coming to IAS Rob held strategy and corporate development leadership roles with financial services firms NetSpend and Rent-A-Center. Prior to his time in financial services, Rob held strategy, finance, and operations roles at Fortune 500 companies spanning the automotive, defense & aerospace, and chemical industries. Rob earned his bachelor’s degree in mechanical engineering from Washington U. in St. Louis, graduating magna cum laude. He also holds an MBA from Harvard Business School. Rob lives in Austin, TX with his wife and two young kids. He enjoys hanging out with his family, distance running, watching Oklahoma Sooners football, and indulging in random interests including knitting, furniture building, and home improvement. You may reach out to Rob via his email: rhumble@iasdirect.com

About the hosts


Gina Cocking serves as the Chief Executive Officer of Colonnade Advisors. Gina began her career in investment banking at Kidder Peabody, was an analyst at Madison Dearborn Partners and an associate at J.P. Morgan & Co. She was the Chief Financial Officer of Cobalt Finance, a specialty finance company. She went on to become the Chief Financial Officer of Healthcare Laundry Systems, a private equity-backed company for which she oversaw the successful sale to a strategic acquirer. Gina served as the Line of Business CFO – Consumer Banking and Lending at Discover Financial Services. Gina serves on the Board of Directors of CIB Marine Bancshares, Inc. Gina received her BA in Economics and an MBA from the University of Chicago.

Jeff Guylay headshot

Jeff Guylay is a Managing Director of Colonnade Advisors. Prior to joining Colonnade in 2000, Jeff was an investment banker at J.P. Morgan in the firm’s Mergers & Acquisitions and Fixed Income Capital Markets groups in New York. He also spent several years in J.P. Morgan’s Chicago office. Jeff has over 20 years of M&A and investment banking experience and has served as lead execution partner on over 25 M&A and financing transactions at Colonnade. Jeff received an MBA from Northwestern University’s Kellogg Graduate School of Management and a Master of Engineering Management from the University’s McCormick School of Engineering. Jeff received a BA from Dartmouth College and a BE from Dartmouth’s Thayer School of Engineering.

About the Middle Market Mergers & Acquisitions Podcast


Get the insiders’ take on mergers and acquisitions. M&A investment bankers Gina Cocking and Jeff Guylay of Colonnade Advisors discuss the technical aspects of and tactics used in middle market deals. This podcast offers actionable advice and strategies for selling your company and is aimed at owners of middle market companies in the financial services and business services sectors. Middle market companies are generally valued between $20 million and $500 million.

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