Selling a business is difficult. Due diligence is often the hardest part of the business sale. Business owners rarely understand why “surviving due diligence” is often the best they can do if they are not thoroughly prepared.
The typical buyer’s due diligence process will be thorough and often invasive to a point where business owners will be discouraged. Sellers must understand that buyers are going to do everything possible to make sure they are investing wisely.
Business buyers’ success is measured by their ability to buy right, grow value and successfully realize returns from their investment. This point is evident in the buying process.
The due diligence period is time for the buyer to investigate, review, and analyze just about anything they think they need to understand about the opportunity before the purchase. The length of due diligence time will be specified and negotiated as part of the letter of intent (LOI).
One of the key things you or your advisor needs to do prior to due diligence is get the diligence list from the buyer and meet with them to cover it in detail. A good advisor will be able to get a lot of information from the buyer at this meeting. The diligence list will also give everyone insight into how difficult the diligence process is going to be.
In the diligence meeting or on the list the buyer will identify any special information or outside verification required for the diligence process. Having this information detailed clearly is critical to getting deals done.
The longer the diligence takes, the lower the chances of getting a deal done.
If you are wondering how much you need to prepare for the diligence process, here are three things to remember
- You are still expected to run the business as normal. Surviving due diligence means the business performance can’t falter during the process, in case if it does, you will be lucky to be presented with a price reduction. but if the performance changes dramatically the deal will be dead.
- You are probably not going to have your team helping you. If the sale of your business is going to be confidential and your team is not involved, you can’t just load them up with strange work and a bunch of people conducting diligence on site. Plus, they have full time jobs in the business as well.
- They won’t probably ask for the easy information. It will likely take twice the time or more to get the information completed you don’t have ready. With you and your employees working on the business you can’t just drop everything and complete information. In a 90 day diligence period it is not uncommon for 30-45 days to be spent waiting for information from the seller. Each of these days is like a time bomb ticking.
The due diligence process is best described as “trust but verify”. Being able to back up everything represented and being ready for any additional question is quite important for the business sellers
Here are some common examples of information business buyers ask for that business owners may not have thought of or detailed.
Projections & growth :
What are your projections for the next 3 years? What are the specific strategies in place to increase your growth? Is your growth strategy utilizing current methods? Where will you need to add resources, when, where, and how much will it cost?
Market size & potential :
What is the total potential market your company operates in? How much of that market do you have already? What market expansion is easily accessible?
Industry risk :
What are the inherent risks of your industry? How have you mitigated the downside risks with your business?
Customers & concentration :
How much revenue is in your top customers? Do you have contracts with customers? What are the lifetime earnings for each customer? Who has the key relationships with the customers, and do they have golden handcuffs?
Management team :
Is the owner key to the business? Is your management team appropriate for the size? Can your management team run the business without ownership?
The biggest and most challenging aspect of surviving due diligence may come from the Quality of Earnings audit. A quality of earnings (QOE) audit is a deep dive into the business by a 3rd party to understand the sustainability and future performance of the business at a detailed level. The QOE is often standard in larger transactions ($10 million +) by the buyers as a key part of the diligence process. In many situations it is beneficial for the seller to complete a QOE just to highlight any potential problems so they can be addressed prior to the diligence process.
Buyers also look at the QOE prior to the sale as a benefit because they can rely upon the financial statements and other financial information more heavily than if not reviewed to this level. Buyers often stipulate that the QOE audit will confirm the company EBITDA used in the value calculations so it may be better to complete for that reason as well.
Regardless of the size of the transaction, here are some of the basic things you should have prepared.
- Financial statements for the last 5 years
- Third party financial review reports (if available)
- Loan documentation for all equipment and vehicles included in the sale
- Property leases
- Equipment leases
- Company formation documents
- Asset list
- Customer list with sales by customer for last 3 years
- Taxes – receipts of payment for last 3 years and current balances
- Income taxes
- Payroll taxes
- State taxes
- Sales taxes
- Business licenses
- Employee handbook & benefits package information
- Insurance policies
- Marketing materials
- Sales presentation(s)
- All documented procedures
Surviving due diligence is tough for most business owners. The process is thorough and tedious. You need to keep your eye on the goal, not the challenges at hand. Preparation is the main way to ensure a successful process.
If you get through the diligence successfully it means you are probably going to sell your business. If you do a really good job of getting through diligence you can sell for the money you expect.