The Complete Guide to Selling a Business: Due Diligence

Selling a business is a long and complex process. You may be ready to sell this year or just curious into what it will take to sell – this series will help. The business sale process can be broken down into core stages – from who you need to hire, to what questions you should be prepared to answer, to how to hand off your company once you’ve signed on the dotted line.

Typically, buyers express interest in a business through three documents – the IOI, LOI, and the Purchase Agreement. An IOI is non-binding and provides proposed terms, valuation and structure to the transaction. LOIs (Letters of Intent) are a more serious step in the process, once they are jointly executed, the seller is typically under exclusivity with the buyer, such that they are not able to meet with other buyers during a stated period of time.

This also signals the beginning of the buyer conducting due diligence on the business in question with the intent of buying it. During the exclusivity period, the buyer must move quickly to determine if they want to proceed. If they do, a purchase agreement is drafted that defines all the details of the transaction – legal, financial, representations, warranties, etc. The purchase agreement is the definitive document outlining the terms of the sale.

James Darnell of KLH Capital wrote a paper on what to expect from the due diligence process, some of which is outlined here.

One of the most critical parts to preparing for the due diligence process is to understand the perspective of the buyer. Since investors are responsible for being wise stewards of their capital, they need to learn about every facet of your business and leave no stone unturned. They are trusted with the money of larger LP investors and they cannot be frivolous with that responsibility.

As a result, it is important to remember that the due diligence process is not personal. Investors are simply trying to best understand your business and, since you have run your business for years and accumulated years of knowledge and understanding, you are the best resource for them.

Investors have knowledge of your financials, company performance, history and structure. But investors will also use the diligence time to learn new information on how to grow your business, possible new products or services that can be offered and the landscape for potential acquisitions or add-ons.

This process can take up to 3-6 months and they will look into five major parts of your company  – overall business, accounting, legal, IT, and environmental.

1. Business due diligence

During this phase, investors want to understand a) the sustainability of the company’s revenue and cash flow streams and b) the prospects of growing your business. To discover this data, the potential buyer will probably request a number of phone calls and meetings with you and your advisor to extract all the wisdom you have built over the years of running the company. Expect questions on nearly every aspect of your business, including: products & services, pricing, supplier relationships, operations, accounting, HR, IT systems and other areas.

Once they understand your particular business, the buyer may investigate the broader industry to help with growth potential plans, and the landscape of products, services, and competition already present in the industry.

The las part of the business due diligence will focus on customers. It is very common for buyers to request calls, meetings, or testimonials from your top customers so they can make sure the customer is comfortable with the transaction, better understand how the customer views your products/services, and to make sure the customer will still want to do business with the company after the deal closes.

2. Accounting due diligence

After analyzing your business and broader industry, investors will begin reviewing your financial performance. This step is mostly confirmatory due diligence – making sure what you told them is the truth.

Practically speaking, this stage of the process will require a great deal of data collection. To make the process as easy as possible, you should be prepared for your financial manager or accountant to be significantly involved in these discussions so they can help collect and prepare the requested information. Once the data is collected, accountants will likely review the information and ask more questions. While this may take a while, this is one of the most critical parts of the diligence process.

3. Legal due diligence

In addition to the financial review of your company, buyers will take a look into the legal side of your business. Their lawyer will review all material contracts to understand any terms and conditions that would result in liability going forward or any materials change in the business.

Additionally, they will review leases to make sure the company will continue to have access to the needed facilities and confirm the terms of the lease are “market.” Other items to be reviewed include any current or prior litigation, the corporate boos to make sure that there is clear title to the stock/assets of the company and all paperwork is in order.

4. IT due diligence

Like most of the other phases of due diligence, the buyer may bring in a third party to review your current IT networks.

These consultants will help the buyer understand the importance of technology to the running of your business, your historical spending on technology, the future expectations for IT budget, and any risks in IT infrastructure that could prove harmful for the business.

5. Environmental due diligence

The last major area of due diligence is a review of the environmental risks associated with your business. The goal of this review is to understand any environmental liability that may be associated with the business or potential for liability in the future. To uncover these issues, the consultant will perform detailed onsite inspections and will review any prior claims and/or issues.

These five core areas of due diligence should be expected from every buyer in a transaction. The best strategy to ensure success is to know what to expect, have the right attitude, and bring the right people onto your transition team. If you do that, you’ll have a successful transaction that accomplishes the goals and objectives that you originally set out to achieve.

The business advisors at Sunbelt Business Brokers are ready to help you prepare for the due diligence process and provide buyers with the necessary materials to complete this important step. Click here to get an advisors assistance.

Some of the material for this blog came from Axial Forum