Avoiding Problems in Due Diligence

Here are tips to consider to prepare for the due diligence process:

• Be Emotionally Prepared: Due diligence can be a grueling undertaking if you’re unprepared. You must be prepared to commit a substantial amount of time and energy to the process. The objective of some buyers is to wear you down, discover problems, and then attempt to renegotiate the terms of the deal. Anticipate this possibility by preparing for due diligence and resolving issues long before a buyer discovers them. You should also attempt to remain emotionally unattached to the process so you can negotiate from a detached, objective perspective. 
• Stay Focused: By the time you reach the due diligence stage, you may feel as if you’re almost done, but this is a critical stage where the sale can still be made or lost. You’re only on the 50-yard line at this point – if you lose focus, your deal can die. There is still a lot of work to be done before the sale is complete. It’s vital that you stay engaged and actively involved in due diligence to reach your goal of a smooth closing. 
• Prepare a Due Diligence Checklist: The best way to keep the complicated process of due diligence straight is to put it to paper. Prepare a checklist to help you stay organized and focused.
• Buyer Type Determines Thoroughness: Individuals are generally less thorough than companies when conducting due diligence. However, some individuals can be especially comprehensive if they’re detail-oriented, risk-averse, or have a CPA or attorney advising them behind the scenes. Most companies are thorough, especially if they’ve completed multiple acquisitions in the past. 
• Exclusivity: Keep your business on the market even after you’ve received an offer unless you have negotiated an exclusivity period with the buyer. 
• Involve Your Accountant: Much of the documentation needed for due diligence is financial in nature. Therefore, including your accountant or CFO in your plans as early as possible will help you prepare for due diligence. The more cooperation you have from your team, the smoother the process will go. 
• Designate a Point Person: The point person should be the quarterback during the transaction. They should review all information before you release it to the buyer, as well as orchestrate communication with all parties involved. Many professional advisors will lose you as a client if the transaction is successful, so they may not be inclined to conclude the transaction quickly due to their hourly-rate fee structure. Being the point person yourself, or appointing someone within the company, will help simplify the due diligence process. 
• Contact the Landlord Early: The lease is one of the most critical elements of the process and needs to be carefully orchestrated. Issues around the transfer of a lease are common, so the process must be handled with care. Landlords can’t be compelled to approve the lease transfer, but delaying the landlord’s involvement can slow the closing or prevent it altogether. I recommend involving the landlord as early as possible in the process. 
• Prequalify the Buyer: Be sure you’ve prequalified the buyer before negotiating and accepting an offer. You want to ensure that you’re negotiating with a buyer who has the financial capacity to close the transaction. 
• Tell the Buyer You Are Prepared: If you’ve prepared your business for sale and organized all the documents, make sure to mention this in early conversations with buyers. You could say something like this:

“I’m a motivated, serious seller who has prepared my business for sale with the help of a CPA. I have all the necessary documents ready for due diligence, including tax returns, leases, equipment lists, financial statements, and more.”

Common Mistakes Sellers Make

By far, the biggest mistake sellers make is not being prepared for how grueling the diligence typically is. A common example of this is when a seller simply tells the buyer to come to the business to look for themselves to see all the money they’re making. Many sellers misunderstand the purpose of due diligence, so they view the buyer’s document requests and thorough diligence as a form of unwarranted suspicion.

A seller’s misunderstanding of due diligence is a red flag to a buyer. It’s a sign that conducting diligence will be time-consuming and difficult. Such a statement only heightens a buyer’s level of concern, and the response is often to conduct more thorough diligence and demand more thorough protections in the purchase agreement. 

Many sellers fear what may happen if the deal doesn’t close – that the company will become tarnished and difficult to sell. Sellers are often uncommitted at this stage, and instead of sprinting to the end-zone, they hee-haw and tiptoe. This lengthens the time it takes to reach the closing, which, as a result, increases risk.

A major element of due diligence is gathering all the information. To expedite this process, you can prepare and arrange in advance the common documents most buyers will request. Any additional documents the buyer requests should be quickly and accurately gathered and assembled for their review. The quicker you organize the documents, the quicker the closing will occur.

Common Mistakes Buyers Make

The biggest mistake buyers make is sending a templated due diligence checklist to the seller and then failing to communicate with them – which results in a lack of trust between the parties and increases the time and difficulty of performing due diligence. Sellers often become defensive and unmotivated to follow through if they see unreasonable requests for information or requests for information they deem irrelevant.

The buyer should understand the impact that performing diligence can have on the target company. The buyer should also be interested in maintaining the financial performance of the company – since they’ll assume ownership if diligence goes as planned.

If you receive what appears to be a templated due diligence list with requests for irrelevant information, it may be wise to have a talk with the buyer.