Why Due Diligence is Required When Selling Your Business

Congratulations! You’ve just received a Letter of Intent from a prospective buyer for your business. Try to contain your level of excitement because, when that Letter of Intent arrives, you still have a lot of work to do before selling your business and the deal closes. From here to closing, expect another 90 to 120 days to get through all necessary steps in selling your business. First step is the performance of due diligence, to provide the would-be buyer with all the information the buyer desires about all aspects of your business.

Typically, a buyer will hire his/her accountant to perform the financial due diligence on your company. The aim is to confirm the initial data provided, determine the financial strengths and weaknesses of the company, and especially, to find any areas of possible risk. The buyer and his accountant will analyze what your company is doing to arrive at the favorable financial picture that you’ve presented.

As the seller of your business, it’s to your benefit to prepare for this due diligence. Be certain that all your financial documents are in order. Not only will this speed up the process, but perhaps more importantly, it will lead to a stronger level of trust between the buyer and seller; the buyer will be assured of getting a fair value in your company.

What to Expect in Due Diligence

You may be startled by what you see in a due diligence request. We have seen requests with up to 200 initial line-item entries and dozens more follow-ups. A request might necessitate a response of hundreds of pages if, for instance, the buyer asks to see all your patent filings or every vendor contract currently in force. A request might also be as simple as asking if your company is involved in any litigation. If the answer is no, that’s simple. If it’s yes, that could mean hundreds more pages of response. Recently, we found ourselves providing more than 2,000 pages responding to due diligence requests.

How to Prepare for Due Diligence

• To be ready for such a lengthy process, we recommend that you pull together all the important documents for your business. Everything from founding documents to employee agreements to trademark certificates. Some of these may have been filed away years ago, perhaps even forgotten about. Get them together, have them scanned and organized. Keep the hard copies in a fireproof cabinet.

• Be sure all your documents are signed and dated by the parties you have contracted with. Contract signature pages are not enough when it comes to due diligence. The entire agreement must be included.

• The buyer will want to review all your customer and vendor contracts. Make sure they are up to date. If some have lapsed but continue to be observed under the mantra of “let’s just keep doing what we have been doing,” that’s not good enough for due diligence. Get them extended, signed, and sealed. In fact, get all your customer and vendor contracts together so they can be viewed as a whole. Don’t wait to get this paperwork done; it will only delay the due diligence process and you will be scrambling for paperwork while the due diligence clock is ticking.

• Because this is so complicated, it is a good idea to work with a business intermediary or broker. The intermediary’s role is to respond to everything from the buyer, his accountant, and his lawyer quickly and accurately.

• It’s a good idea to set up a secure shared data space with the intermediary. Perhaps a password-protected ShareFile or Dropbox where business files can be exchanged quickly and securely. This is a meticulous process, and it may be helpful to keep track of everything going into the data room with a spreadsheet of due diligence requests.

They can be categorized in three ways:

1. A straightforward question. This can be answered with a simple explanation, maybe even one sentence, which can be uploaded to the data room.
2. A request that can be answered by uploading business documents.
3. A request that requires more than a simple explanation and may involve creating new documents.

If a substantive answer is required involving the creation of new documents, be thorough in your explanation. Answer and explain, but there’s no need to go into exhaustive detail.

What’s Next?

Once due diligence answers have been submitted to the buyer, and the buyer has had time to review the answers, there usually is a follow-up period consisting of in-depth phone calls or in-person meetings. We find it helpful, before each call, to get an idea of questions that may arise prior to the meeting, so the seller of the business can be better prepared with suitable answers.

Don’t think all this work is for nothing. You can be certain that the accountant and attorney for the buyer will be going over absolutely everything you submit in due diligence.

The due diligence process is intense, and it can be exhausting. It provides you, the seller, the opportunity to go over everything in your company’s history and to evaluate every process and function. At the conclusion of due diligence, the buyer will decide whether to move forward with the terms of the deal or not. By being prepared and ready for due diligence the chances are better for a timely and successful sale closing.

Want to Know More?

If you want to know more about selling your business, then click on the image below to download our selling a business checklist. It offers six simple steps to follow to get your business ready for a sale:

If you need help putting together a strategic plan, please contact the Benjamin Ross Group at 215-357-9694 to speak with a business broker who can help you start the process.