Key points
- Governance failures, such as weak financial controls and outdated systems, are among the top deal-breakers uncovered during due diligence.
- Buyers are increasingly wary of hidden risks like inconsistent revenue recognition, legacy tech debt, and problematic contract clauses.
- In today’s M&A landscape, sellers who proactively address governance and transparency are far more likely to succeed.
Why governance failures derail deals
Strong governance is supposed to underpin a robust business.
Yet when it comes to M&A, investors regularly find companies that lack basic financial controls, systems, process or uncover dirty secrets when it comes to opening the books.
These are the deal-killers that can derail even the most promising transactions. You only get one shot to make a good impression when you open the books to a suitor.
In an increasingly complex M&A landscape, the sellers who succeed are the ones who take governance seriously, get their systems in order, and welcome scrutiny.
For those who hope to tizzy up a struggling or poorly managed business for sale, it is now a far riskier prospect.
The reasons for poor governance are many and varied – the company may have been through a period of rapid growth, or there may be legacy issues associated with founders or operations that are no longer fit for purpose but have never been updated.
In many cases, governance is more about perception than practice.
Boards sign off on policies they don’t enforce, executives inherit systems they don’t fully understand, and financial rigour takes a backseat to short-term growth targets.
Without continual scrutiny and accountability, even well-intentioned structures become box-ticking exercises. The result? A veneer of control that crumbles under the spotlight of due diligence.
Businesses lacking proper monthly management accounts or cash flow statements often still use cash accounting. This approach paints an incomplete – and sometimes misleading – financial picture.
In one eyebrow-raising case, a company failed to provide monthly cash flow statements to a board – and this was considered acceptable practice. If the stewards of governance are willing to accept this kind of lax oversight, it raises serious red flags for buyers.
Hidden risks buyers uncover
Here are three common sources of hidden risk that can derail a deal:
- Revenue Recognition and Accounting Policies: Do the Company have consistent accounting policies aligning with AASB/IFRS Standards and that Management have not manipulated accounting policies or frequently changing accounting policies? Review “docs to dollars” for material revenue contracts.
- Tech debt: Is your tech infrastructure outdated or overly reliant on custom solutions that are expensive to maintain? Buyers may view this as a costly liability.
- Contracts and agreements: Are you aware of all the clauses in shareholder agreements or client contracts that might pose significant risks? For instance, commitments to issue additional shares at discounted rates or performance-related liabilities tied to old agreements can erode value if left unchecked.
Details buried deep in shareholder agreements or long-term contracts may have made sense at the time, like commitments to issue extra shares at discounted rates as an incentive.
But without proper understanding and context a buyer will see them as timebombs that could explode into hefty claims or liabilities.
In one case, we found a startup considering a sale who had an agreement with existing shareholders to convert shares at rock-bottom values, which would quietly undermine value for new investors – unless it was uncovered.
There is another side to due diligence – the people. One of the biggest red flags in a sale process is when too much of the business walks out the door with the founder.
If key relationships, decision-making, or operational knowledge all rest with you or a small handful of long-timers, buyers will see risk, not value. It’s necessary to quantify a capable team, clear systems, and a culture that will endure beyond the handover.
Preparing your business for scrutiny
So what does this mean if you are preparing your business for sale?
Founders are often unrelentingly optimistic, which is part of what makes them great entrepreneurs.
But that optimism needs to be balanced with hard-nosed scrutiny – before you go to market. An external party can prepare the team, probe with precision, and ensure the facts match the vision.
Most sellers focus on revenue growth and profitability, and this is the shop window that draws in the buyers in the first place. But then buyers will dig deeper into the less obvious areas, such as sustainable earnings and free cash flows, working capital requirements and long-term liabilities that could impact future performance.
Other key areas that are catching investor attention include ESG practices, legacy underpayment risks due to complex award systems, and how AI adoption (or lack thereof) could impact future performance and productivity.
Buyers will ask tough, sometimes uncomfortable questions. They’ll want to know about everything from historical tax compliance to customer retention rates, and then they will want documented proof.
If you’re unprepared, these inquiries can catch you off guard and create doubt about your readiness to sell.
With economic headwinds, regulatory pressures, and strategic uncertainty, due diligence timelines are stretching.
Sellers need to be ready, not just with tidy financials, but with openness and honesty about any issues that could throw a spanner in the works and avoid springing any surprises at the eleventh hour.
The sellers who succeed will be those who see due diligence not as a burden, but as an opportunity to demonstrate strength, transparency, and control.
Due diligence isn’t about hoping for the best – it’s about knowing you’re the best option and having the data and detail available to prove it.
