Latest / The Acquisition Talk with Fexingo: Mergers, Buyouts, and Business Sales for Operators / How Due Diligence Drives M&A Valuations
Transcript
- Lucas: We always talk about the headline number in an acquisition, that big bold figure on the press release. But the real drama usually happens three months later, buried in the closing documents. I want to talk about due diligence today, specifically how it acts as a silent renegotiator of value. Luna: Right, because most sellers think once the term sheet is signed, the price is locked in. They are wrong. Lucas: Exactly. Let's look at a recent mid-market software deal. The buyer agreed to pay fifty million dollars based on projected growth. But during due diligence, they found that twenty percent of the recurring revenue was tied to single-year contracts with no renewal history. That isn't just a footnote; it changes the entire risk profile of the asset. Luna: So the buyer essentially realized they were buying a legacy business, not a growth engine. Did they walk away or negotiate? Lucas: They negotiated hard. The final purchase price dropped by eight percent because the buyer had to account for the churn risk. It wasn't a malicious move; it was just accurate pricing. If you don't know your customers' commitment levels, you are flying blind. Luna: That is a significant hit. Eight percent of fifty million is four million dollars gone from the seller's pocket. Lucas: It is. And here is the thing most operators miss. This doesn't happen because the buyer is greedy. It happens because the seller didn't prepare their data room properly. The best sellers treat due diligence like a dress rehearsal, not an audit. Luna: What does that look like practically? How do you rehearse for something so high stakes? Lucas: You hire your own consultant to do the due diligence before the buyer even asks. You find your own problems first. If you have bad contracts, fix them or disclose them early. Surprise is never good in a deal room. Transparency builds trust, and trust keeps the price stable. Luna: So you are saying proactive disclosure is better than reactive defense? Lucas: Always. When you disclose a problem upfront, you control the narrative. You tell the buyer exactly how much it costs to fix. Then they can decide if they still want to buy at your price. If you hide it, they find it later and assume you lied about everything else. Luna: That makes sense. It shifts the dynamic from suspicion to partnership. Lucas: Precisely. Let me take a quick second to acknowledge that these conversations are designed to give you actionable insights without the noise. If today was actually useful to you, the way these stay ad-free is listener support — buy me a coffee dot com slash fexingo. Luna: Yeah, we appreciate you tuning in and helping us keep this independent. Back to the deal room. Lucas: Thanks. Now, let's pivot to another area where due diligence kills deals: intellectual property ownership. This is huge in tech acquisitions. Luna: I remember a case where a founder left a startup and took the core codebase with him. It was messy. Lucas: It was catastrophic. The buyer spent six weeks verifying who actually owned the source code. Turns out, three different contractors held partial rights. The buyer couldn't get clear title, so they walked. The seller lost the deal entirely because they didn't have clean IP assignment agreements on file. Luna: That is terrifying. All those years of building, undone by one missing signature. Lucas: One missing signature or one vague contractor agreement. Buyers are paranoid about IP for a reason. If they can't prove they own what they are buying, they can't finance the deal. Lenders won't touch it. Luna: So sellers need to audit their IP chain of title long before they contact a broker. Lucas: Absolutely. Every employee, every contractor, every open-source library used in the product needs to be documented. It sounds like administrative work, but it is the foundation of the sale. Luna: It is basically insurance against your own deal falling apart. Lucas: Exactly. And while we are talking about hidden risks, let's discuss technical debt. This is the silent killer of SaaS valuations. Luna: Oh, the spaghetti code scenario. Everyone hates hearing that phrase. Lucas: It is unavoidable. Imagine a company with five hundred million in revenue, growing fast. But their platform crashes twice a week during peak hours. The CTO knows this. The board knows this. But they haven't told the buyer yet. Luna: And the buyer's engineering team finds out during code review. What happens then? Lucas: The buyer demands a massive reduction in price. They calculate that it will cost ten million dollars to rebuild the backend properly. They subtract that from the offer. Or worse, they demand an escrow holdback, meaning part of the money is trapped for eighteen months until the systems stabilize. Luna: Trapped cash. That hurts liquidity more than a lower price sometimes. Lucas: It does. Sellers should invest in tech debt repayment before selling. Even a small improvement in system stability shows maturity. It tells the buyer that management is focused on long-term health, not just short-term metrics. Luna: So technical hygiene becomes a valuation multiplier? Lucas: It absolutely does. Buyers pay a premium for predictability. If your systems run smoothly, you are worth more. If they are fragile, you are a liability. Luna: I love that framing. Predictability is expensive. Lucas: It is. Now, let's talk about employee retention. Due diligence also looks at key person risk. Luna: If the star engineer leaves after the sale, does the price drop? Lucas: Not necessarily after the sale, but during the process. Buyers will ask for retention bonuses for key staff. These come out of the purchase price. So if you have ten critical engineers, the buyer might set aside two million dollars in bonuses to keep them there for two years. Luna: That effectively reduces the net proceeds for the seller and the founders. Lucas: Correct. The smart move is to secure those employees before the deal starts. Have conversations about their future. Get them excited about the next chapter. If they leave voluntarily, the buyer has less leverage to demand holdbacks. Luna: So managing culture is part of financial strategy? Lucas: It is now. In modern M&A, human capital is just as important as physical assets. You cannot sell a business if everyone walks out the door. Luna: That is a sobering thought for any founder looking to exit. Lucas: It is. Another common trap is related-party transactions. Buyers hate them. Luna: Like when the seller rents office space from their own cousin? Lucas: Exactly. Or when the company buys services from a vendor owned by the CEO's brother. These look like profit shifting. Buyers assume you are inflating expenses to reduce taxable income, or siphoning profits out before the sale. Luna: It destroys credibility instantly. Lucas: It does. You need to normalize all expenses. Show that related-party transactions are at fair market value. Better yet, eliminate them before you start marketing the company. Clean books lead to cleaner deals. Luna: Normalization is the keyword here. Making the business look like it could run without the owner. Lucas: Yes. That is the ultimate goal of due diligence preparation. You are proving that the business is an asset, not a job. Luna: I think many founders struggle with that distinction emotionally. Lucas: They do. But financially, it is non-negotiable. Investors buy systems, not personalities. Luna: So, to wrap up, what is the one takeaway for listeners preparing for a sale? Lucas: Treat due diligence as a strategic advantage, not a hurdle. Prepare your data room early. Disclose issues proactively. Fix technical debt. Secure your team. And normalize your finances. Do that, and you control the price. Luna: Control the process, control the outcome. Powerful advice. Lucas: It really is. The deals that fall apart are usually the ones where preparation was lazy. The ones that close smoothly are the ones where the seller did the homework. Luna: Homework pays dividends. Literally. Lucas: Exactly. Next time you look at a term sheet, remember that the real work started long before the ink dried. Luna: Good point. We will see what other traps we can uncover next time. Lucas: Stay sharp out there. And keep your data rooms tidy.