Getting ready for due diligence requires the seller to plan ahead, but the investment of time can pay off in several ways. First, anticipating the types of information that a buyer may want will help minimize delays that can lead to a loss of momentum in negotiations. In addition, having an advance preparation strategy bolsters the impression that the seller’s business is run professionally. That may increase the prospective buyer’s confidence in the value of the company and could lead to a higher sale price.
Here are some of the major areas that sellers should anticipate when preparing to run the due diligence gauntlet.
Any buyer will (or should) want to undertake a comprehensive financial review of the business. For larger (over $2 million) transactions, the seller also should prepare audited financial statements (balance sheets, earning statements, and cash flow statements) for the current year-to-date and the three prior years. Buyers also will want to inspect the business property and equipment.
Sellers should have a list of expenses that will not be considerations for a buyer, including what the current owner takes out of the business and any related expenses such as “fringe benefit” expenses like golf club memberships, company paid vehicles, and the like.
Itemize the company’s intellectual property (IP), such as patents, inventions, designs, copyrights, trademarks, service marks, trade secrets, computer programs, confidential information, and know-how. This should include a list of company IP as well as the documents, including any licensing or royalty agreements, relating to use of the IP.
Help the buyer understand how your business works by summarizing current processes and procedures, listing key supplier and vendor relationships, explaining inventory management, management systems, and customer relations.
One asset that business owners often overlook (and undervalue) is the company’s intellectual property (IP). The World Intellectual Property Organization defines IP as creations of the mind — inventions, literary and artistic works, symbols, names, images, and designs used in commerce. The law recognizes four categories of intellectual property. We’ll spend some time with each of these in future posts, but here’s a quick overview to get started:
Patents protect inventions such as machines or processes. If properly registered with the US Patent and Trademark Office, patents provide inventors with an exclusive right to manufacture and market their invention. Federal patent protection lasts up to 20 years.
A trademark is a name, phrase, sound, or symbol used in connection with services or products. Think of Nike’s swoop or the phrase “Just do it.” Federal trademark protection lasts for 10 years after registration and can be renewed “in perpetuity.” Trademarks can also be established without formal registration. If a company creates a symbol or name it wishes to use exclusively, it can simply attach the TM symbol to identify and protect the mark under common law; however, it is easier (more cost-effective) to enforce federally protected trademarks in court).
Copyright laws protect written or artistic compositions such as books, poems, songs, or movies. A copyright protects the expression of an idea, but not the idea itself. The owner of a copyrighted work has the right to reproduce, sell, perform, or display the work to the public. An author can have a common law copyright without federal registration, but cannot sue for copyright infringement of an unregistered copyright. A copyright lasts for the life of the author plus another 50 years.
Trade secrets include formulas, patterns, devices, or compilations of data that give a competitive advantage in business. Unlike the first three categories, trade secrets are governed by state law. To protect the secret, a business must prove that it adds value to the company and that appropriate measures have been taken within the company to safeguard the secret.