Selling
Agency sale due diligence: what buyers test and how to prepare
Due diligence is where the buyer tests everything it has been told. This guide explains what buyers try to establish, the agency specific issues that come up most often, how findings change price and terms, and how to prepare so that there are no surprises on either side.
In short: Buyers use diligence to confirm that earnings are real, clients and people will transfer, liabilities are known and the deal can complete. A finding can lead to further investigation, an adjustment, a change of structure, contractual protection, remediation or, in some cases, withdrawal, depending on materiality, evidence, whether it can be fixed, who is best placed to carry it, the buyer’s appetite and its financing. The seller’s job is to know the issues first, disclose them in an organised way and have a response ready. Preparation reduces surprises; it does not guarantee an unchanged price, because some findings are legitimate reasons to revisit terms.
What buyers are trying to establish
Every diligence workstream answers one of four questions: are the earnings real and repeatable, will the business transfer intact, what liabilities come with it, and can the deal complete on the terms agreed. Findings can feed into sustainable earnings, the valuation, the adjustments to equity value, the buyer’s financing, the structure (how much is deferred or contingent), the contractual protection (warranties, indemnities, retentions), the timetable and, in some cases, the decision to proceed at all. One finding can touch several of these at once.
The workstreams, and what they find in agencies
| Workstream | Agency specific issues | Where it bites |
|---|---|---|
| Financial | Revenue recognition on projects and retainers; principal versus agent treatment of pass-through costs and the reconciliation from gross billings to net revenue; WIP and accrued income; project margins and write-offs; normalisation adjustments; monthly working capital; cash conversion | Sustainable EBITDA, price mechanism, working capital target |
| Commercial | Client retention and concentration; contract terms and notice periods; pipeline quality; pricing; competitive position; dependence on platforms or a few channels | Multiple, earnout design, deal viability |
| Legal | Client and supplier contracts; change of control clauses; IP ownership and assignments; disputes; property; regulatory matters | Warranties, indemnities, conditions to completion |
| People | Employment terms; contractor and freelancer status; options and bonuses triggered by a sale; key person dependence; restrictive covenants | Retention terms, price, indemnities |
| Tax | Corporation tax and VAT compliance; employment taxes on contractors; option scheme treatment; related party arrangements | Indemnities, retentions, structure |
| Technology, data and cyber | Systems ownership and licences; proprietary tools and who built them; data protection compliance; client data handling; security incidents | Warranties, remediation conditions, integration cost |
| Operational | Delivery process, utilisation, supplier dependence, deposits and client money | Integration plan, working capital |
Sector shapes the emphasis. Experiential and events businesses are tested on project margin, deposits and cancellation terms. Performance and media agencies on pass-through spend and platform dependence. Content, production and creator businesses on contractor created IP, usage rights and talent contracts. Technology enabled businesses on code ownership and the split between product and services revenue.
Vendor preparation, vendor due diligence and buyer diligence
Vendor preparation is the seller getting its own house in order: defined numbers, a reconciled bridge, contracts reviewed, IP assigned, issues identified. Every seller should do it.
Vendor due diligence is an independent report commissioned by the seller and shared with buyers. It costs money, and it suits competitive processes with several buyers, larger transactions and businesses with complex numbers, because it keeps every buyer working from the same findings and shortens their own work.
Buyer diligence is the buyer’s own investigation, through its advisors, after exclusivity. It happens in every deal, whatever the seller has done, and it is where findings turn into price and terms.
How findings change the deal
A finding has consequences in proportion to what it changes, and a single finding can touch several parts of a deal. Revenue recognised ahead of delivery changes sustainable EBITDA; it may also leave a deferred revenue balance that the buyer treats as debt-like in the equity bridge. Those are distinct effects, and counting both is legitimate: one concerns the run rate of earnings, the other a liability to deliver work that has already been paid for, and each needs its own evidence. A change of control clause in the largest client contract may become a condition to completion, a retention, a reason to revisit the forecast, or nothing at all, depending on the client’s likely response. A contractor who should have been an employee may be handled through an indemnity for the past, a price adjustment for the ongoing cost, or both. A security incident may become a remediation condition or a warranty. What decides the response is materiality, the evidence, whether the issue can be remedied before completion, who is best placed to carry it, the buyer’s appetite and its financing. The seller’s aim is to know each issue first and arrive with a response.
Finding. Financial diligence shows that the business records revenue when it invoices. Some invoices are raised ahead of the work, so each year end includes amounts billed for services still to be delivered. The example below corrects two years of revenue for opening and closing deferred revenue. Assumptions: all amounts exclude VAT; there is no unbilled revenue or other revenue adjustment; opening deferred revenue is earned during the year; closing deferred revenue relates to services delivered after the year end; and, for this illustration only, operating costs have already been recognised in the correct periods.
| GBP 000 | Year 1 | Year 2 |
|---|---|---|
| Revenue originally recorded from invoices | 1,000 | 1,100 |
| Add opening deferred revenue earned in the year | 80 | 100 |
| Deduct closing deferred revenue | (100) | (160) |
| Corrected revenue | 980 | 1,040 |
| Reported EBITDA | 200 | 220 |
| Revenue correction | (20) | (60) |
| Corrected EBITDA, under the stated cost assumption | 180 | 160 |
What the example establishes. Reported revenue growth of 10 per cent becomes about 6 per cent once timing is corrected, and reported EBITDA growth becomes a decline, because the closing deferred balance grew faster than the opening one. The business also carries a £160,000 obligation at the end of year 2 to deliver work it has been paid for, which the buyer will consider in the equity bridge separately from the earnings effect.
What still needs investigation. The EBITDA adjustment equals the revenue adjustment only because of the explicit assumption about costs. In practice diligence must examine the costs associated with the deferred work: if delivery costs were also deferred, or if the invoiced work is largely delivered at the point of billing, the earnings effect is different. The correct treatment depends on the accounting framework that applies to the business and the period in question (in the UK, for example, FRS 102 or IFRS, in the version in force for that year), on the contracts, and on the agency’s stated policy. Diligence tests the policy, the evidence for it and whether it has been applied consistently.
Response. A seller who has identified this before the process presents the corrected figures from the start, with the policy written down and the deferred balances reconciled, so that the offer is built on numbers that survive diligence.
Buyers revise offers for three kinds of reason: diligence finds something the information did not show; trading during the process falls short of forecast; or the buyer senses the seller has no alternative. The first is legitimate and preparation reduces it. The second is why the business must keep performing. The third is why a credible fallback matters. Not every revision is opportunistic, and good preparation does not guarantee that the number agreed at heads of terms survives untouched.
Running the process well
Organised disclosure, with issues set out in a disclosure letter against the warranties, protects the seller afterwards. Management responses should be accurate, prompt and consistent across workstreams, because advisors compare answers. Escalate anything significant to the principals early, so it is negotiated once and not discovered twice. Keep the data room disciplined: version controlled, indexed, and with a log of what each buyer has seen.
Diligence runs through a question and answer process, usually in a shared tracker, with the buyer’s advisors asking by workstream and the seller answering within agreed turnaround times. Three habits make it work. Route every question through one person on the seller’s side so that answers are consistent and nothing is promised twice. Answer the question asked, with the document that supports it, and say when something does not exist instead of producing a version of it for the occasion. Keep a running list of the points that will need to be disclosed against the warranties, so that the disclosure letter is built as the process runs and not assembled under pressure at the end.
The seller’s own team has defined roles. The M&A advisor manages the flow of questions, judges which findings matter and negotiates their consequences. The lawyers handle legal diligence responses and the disclosure letter. The accountants support the financial responses and challenge the buyer’s analysis where it is wrong. Management provides the facts and keeps the business running, which in a long diligence period is the hardest part.
Readiness checklist
- Management accounts reconciled to statutory accounts, ideally for three years, with gross billings, reported revenue, net revenue and gross profit defined and reconciled.
- Reconciled normalised EBITDA bridge with evidence for each adjustment.
- Monthly working capital and cash, ideally for 24 months; deposits and deferred income explained.
- Revenue recognition policy written down and applied consistently.
- Top twenty client contracts reviewed for term, notice and change of control.
- IP assignments in place for employees, contractors and freelancers.
- Contractor status reviewed; options, bonuses and sale triggers documented.
- Related party balances and property arrangements explained or settled.
- Data protection and security position documented; incidents disclosed.
- Known issues listed, with evidence and a proposed response for each.
What to do next
Work through the checklist and list the issues you would not want a buyer to find first. That list is the preparation plan. The preparation guide covers the financial and organisational work in detail, and we help owners through it on the prepare for a transaction page.
Want to know what a buyer would find?
A confidential conversation with a founding partner about where the issues are and how to deal with them. Speak to us.
Written by Rick Palmer and Rob Reid, founding partners of Motion Advisory Partners. General guidance, not advice on any specific business or transaction. Legal and tax points vary by jurisdiction and should be checked with appropriate advisors.