Preparing for Due Diligence

Due diligence is the buyer’s investigation of every aspect of your business and is conducted in four primary areas:

  1. Operational due diligence
  2. Financial due diligence
  3. Legal due diligence
  4. HR due diligence

Each of these areas can benefit from proper preparation. Here’s why you should prepare for due diligence, the benefits it can provide, and how to go about preparing your business for the grueling process of due diligence. 

The Importance of Preparing for Due Diligence

If you don’t prepare for due diligence, it can turn into an expensive and time-consuming undertaking. Therefore, preparation is a crucial step in selling your business quickly and for maximum value.

The primary purpose of preparing for due diligence is to address potential problems before they’re discovered by buyers. To attract a sophisticated buyer to your company, you want to make sure your business is in the best condition possible. Preparing your business for sale dramatically increases your chances of success. Laying the groundwork for due diligence decreases the buyer’s perception of risk in your business and may even convince them to agree to a shorter due diligence period and less restrictive protections in the purchase agreement.

When selling a business, time is your greatest enemy. Time kills all deals – eventually. By organizing documents so they’re ready for review, you’ll shortcut the process. You may also increase the chances of receiving an offer since buyers are often reluctant to make an offer on a business they may have concerns about. 

Buyers don’t want to risk the time and financial investment in performing due diligence only to find an undisclosed problem. Preparing for due diligence mitigates these concerns for buyers. It also means you’re ready for the buyer to start reviewing documents immediately after you accept an offer, which can potentially speed up the process and dramatically improve your chances of closing the deal.

I highly recommend you prepare for due diligence as early as possible. This is where your accountant or CFO can really help with gathering the documents you need. 

In one transaction I worked on, due diligence was significantly delayed because the seller didn’t have copies of bank statements on hand, and it took several weeks to obtain the original documents from the bank. This delay ended up resulting in a price concession because the economy showed signs of weakening during this period. If the seller had prepared for due diligence in advance, this likely would not have happened and the seller would have put an additional $3 million in their pockets at the closing table.

By taking the time and effort to prepare your business for sale, you also demonstrate to the buyer that you’re serious about exiting your business. Buyers prefer to deal with sellers who are both motivated and prepared, and are reluctant to invest time with any sellers who they believe are anything less than committed to the process.

Benefits of Preparing for Due Diligence

By properly preparing for due diligence, you will:

Resolve Issues Before They Become Dealbreakers: When a buyer decides to pursue the acquisition of your business, they’ll conduct thorough due diligence before they commit to the transaction. Unexpected issues that arise during the buyer’s investigation may potentially kill your deal. You can resolve many of the issues before a buyer ever learns of them with advanced warning of any unsettled problems. Further, a problem identified in advance that can be explained will keep your credibility intact. Preparing for due diligence enables you to work out problems before a buyer even comes into the picture. 

For example, issues with financial records, if not addressed beforehand, usually trigger demands for a lower price, more restrictive terms, or may cause the buyer to walk away from the sale entirely.

Improve the Odds of a Successful Transaction: Preparing for due diligence allows your advisor team to correct potential problems in advance and helps avoid pitfalls to a sale before you expose your business to buyers. With inaccurate financial records, you run the risk of losing a buyer because once the buyer discovers the defects during due diligence, the sale must be delayed to address the problems. After spending many months finding a buyer, losing them over something that could have been corrected from the outset is a disappointment and a waste of valuable time, money, and resources. This scenario plays out more often than sellers realize because, despite working in their business full-time, owners are often unaware of seemingly simple issues. But those simple issues can have a material effect on a buyer’s perception of the relative risk of a company if they aren’t resolved in advance. 

Retain a third party to examine your financials – profit and loss statements, balance sheets, and federal income tax returns – and scrutinize key ratios, trends, and other data, and then provide you with a report of their findings. This helps spot potential issues a buyer may find with your financial records and allows you to address these issues before you ever receive an offer.

Speed Up the Due Diligence Process: Having your financial records in order before selling your business can speed up the due diligence process once you accept a letter of intent, resulting in a higher chance of closing the deal. This is because a buyer who finds issues with your financial records will most certainly conduct due diligence more thoroughly, looking for problems in other areas as well. Shoring up problems before due diligence shows buyers that you and your business are trustworthy. As a result, they may review your records with less scrutiny or curtail due diligence altogether, thus making it more likely your deal will close. 

Maximize Your Sale Price: Conducting pre-sale due diligence maximizes the value of your business by identifying issues early on to avoid complications that can affect the transaction. Simply put, the more organized your business’s financial records appear, the more likely you’ll sell your business quickly and receive top dollar for it. A thoughtful evaluation of your business before the sale process begins will make the undertaking much more manageable, efficient, and cost-effective for you.

Increase the Strategic Knowledge of Your Business: Through the process of preparing for due diligence, members of your advisor team will come to know and understand your company as well as you do – and far better than a potential buyer. This understanding enables your transaction advisor to prepare a confidential information memorandum (CIM) and other marketing materials that fully describe and highlight the strengths of your business. Highlighting your business’s strong points and being fully prepared to explain its intricacies will put you in the best possible position to sell your business for top dollar.

How To Prepare for Due Diligence 

Getting your business ready for due diligence is a relatively straightforward endeavor. It involves assembling and organizing the documents that most buyers request and review during the due diligence period. It may also involve retaining a third-party expert to review these documents and uncover any issues the buyer may discover during due diligence. You should then address any problems once they’re uncovered before you go to market. 

Preparing for financial due diligence is one of the most important parts of successfully closing the sale of your business. The number one deal-killer of business sales is incomplete or inaccurate financial records. This should prompt you to ensure that your financials are in order beforehand. It’s far easier to address potential obstacles to a successful negotiation on your own time without the added stress of the transaction being dependent on its outcome. Otherwise, you risk losing the buyer since financial inaccuracies will most likely be discovered during due diligence. 

No business owner wants to invest enormous amounts of time with a buyer only to lose them to something that could have been prevented. Pre-sale financial due diligence should be conducted by a third party, preferably a CPA with experience in conducting a quality-of-earnings analysis (Q of E). A third-party professional will be able to look objectively at your business and spot mistakes you might otherwise miss. Ideally, this should be performed at least three to six months before beginning the sale process. This will give you ample time to resolve any issues before the buyer even sees them.

Preparing for financial due diligence is one of the most important parts of successfully closing the sale of your business.