Do Your Due Diligence Homework

Do Your Due Diligence Homework


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.

How to Do Due Diligence

How to Do Due Diligence

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An investor approaches a business owner with an attractive offer to buy the business. There is an initial meeting and general deal points are discussed. A rough outline of the terms is sketched out on the proverbial napkin and the parties shake hands leaving the owner thinking they have a deal subject only to a few details to be worked out.

Then the investor starts with due diligence. It begins with a few questions trickling in. Then the first round of answers leads to new questions, and the trickle turns into a stream, and then a torrent. Spending so much time responding to questions diverts the company management away from its primary responsibilities. The investor becomes frustrated with the delayed responses and with the incomplete or contradictory information. The owner is frustrated by the amount of time and effort that is being used and may perceive the questions as signaling lack of trust or commitment from the buyer.

If the buyer is serious and likes the responses to the initial questions, then a team of advisors, including lawyers, CPAs and auditors, may come in for an even more comprehensive set of demands for information. The company undergoes even greater stress, and tensions increase. Under these circumstances, it is not unusual for negotiations to break down, and what could have been a good deal turns into no deal at all.

Most due diligence is done after a potential buyer makes a provisional offer. The due diligence process then begins, often with a very short timeframe for the seller to respond.

Selling a business involves a potentially complex transaction or series of related transactions. Unlike the sale of say, commercial real estate, selling a business involves significantly greater advance planning and hard work ahead of time for the seller. In the next series of posts, we’ll discuss some steps that sellers can take beforehand to make the due diligence process a little easier to navigate.