Sample Due Diligence Checklist

Here is a sample due diligence checklist:

Operations

• Advertising contracts
• Customer list
• Inventory count
• List of key competitors
• Marketing material
• Operations manual
• Preliminary equipment inspection 
• Premises lease
• Summary of key lease terms
• Supplier and vendor list
• Supplier and vendor contracts

Insurance

• Health insurance policies
• Liability insurance policies
• Workers’ compensation policies and history

Assets

• Description of any real estate owned
• Equipment inspection
• Equipment leases
• Equipment list 
• List of all assets included in price
• Inventory list

Financial/Tax

• Accounts payable schedule
• Accounts receivable aging schedule
• Annual personal property tax certificate
• Backup data of adjustments to financials
• Bank statements
• Breakdown of sales by customer
• Breakdown of sales by product type
• Copies of existing loan or financing agreements
• Customer or client agreements
• Documentation for add-backs to financial statements
• Federal income tax returns
• Financial budgets and projections
• Full QuickBooks or accounting software file
• General ledger or detailed list of all transactions and expenses
• List of monthly sales since inception
• Merchant account statements
• Payroll tax reports
• Profit and loss statements
• Sales and use tax reports
• Utility bills

Staff

• Benefit plans
• Compensation arrangements
• Detailed schedule of payroll expenses
• Employment, agency, and independent contractor agreements
• Job descriptions
• List of outside contractors
• Other employment-related agreements
• Overview of personnel turnover
• Schedule of owners, officers, employees, independent contractors, consultants and their titles, length of service, and compensation benefits
• Summary biographies of key management

Legal

• Articles of incorporation/organization
• Business license
• Certificate of Status/Good Standing from the applicable Secretary of State
• Copies of licenses, permits, certificates, registrations, and other documents from all governmental authorities
• Copies of all key contracts
• Corporate/LLC by-laws or operating agreements
• Corporate/LLC minutes
• Description of environmental liabilities
• Fictitious business name statement (DBA)
• Financing agreements
• Information for copyrights
• Information for patents
• Information for trademarks and service marks
• List of liens against the business
• Other third-party agreements or contracts
• Pending lawsuits
• Phase 1 and 2 environmental studies
• Preliminary UCC search results
• Previous purchase agreement and related business documents
• Resale permit
• Seller’s disclosure statement

To download an editable spreadsheet version of this checklist, visit the Downloads section under the Resources menu at morganandwestfield.com.

Other Specialists 

Depending on the nature of your business and industry, other specialists may be employed during due diligence. In some cases, retaining experts in advance can mitigate risk for the buyer, and the buyer may, in turn, reduce the scope of the reps and warranties in the purchase agreement.

• Environmental: You may want to consider hiring an environmental consultant if your business handles hazardous materials or is subject to environmental regulations. Buyers often hire environmental experts if they are purchasing land or buildings and suspect the property may be contaminated. Many jurisdictions impose strict liability for all past owners of real estate when environmental issues arise. Such issues represent the highest exposure levels for the parties. Retaining a consultant in advance may give you time to discover and address problems before they arise with the buyer. 
• Employee Benefits: Employee benefits are the next-largest area of risk exposure for buyers. You should consult with experts in this area well in advance of the sale to ensure assets exceed liabilities in the case of retirement plans. Also, ensure that a smooth transition of benefits can occur in the case of other benefits, such as deferred compensation, profit-sharing, stock options, employee stock ownership, health insurance, and life insurance. In most cases, the plans will be terminated and you will be obligated to fulfill the termination requirements while the employees continue under the buyer’s plan.
• Code Audit: When purchasing a software company, most buyers retain a third party to perform a code audit to be certain the software code is clean and well documented. A wise seller will hire a third party to perform the audit and clean up the code before the company is put on the market. The results of the audit and cleanup can then be used as negotiating leverage to provide the buyers with some level of comfort regarding the documentation, accuracy, and organization of the code.

Due diligence can be grueling. Be prepared to commit a substantial amount of time and energy to the process. 

Tips for Conducting Due Diligence

Be Emotionally Prepared: Due diligence can be grueling. 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 during due diligence, and then attempt to renegotiate the terms of the deal. Anticipate this possibility by preparing for due diligence so issues are uncovered and resolved 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.

Determine Buyer Type: The type of buyer you negotiate with can determine how thorough they will be during the sales process. Individuals are generally less thorough than companies in conducting due diligence. But some individuals can be especially thorough if they are detail-oriented, are quite risk-averse, or have a CPA or attorney advising them behind the scenes. Most companies are thorough, especially if they have completed multiple acquisitions in the past.

Keep Your Options Open: Keep your business on the market, even after you’ve received an offer, unless you have agreed to an exclusivity period with the buyer.

Don’t Lose Focus: You must be prepared to spend significant time and energy during the due diligence process. 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 be made or lost. 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 in order to reach your ultimate goal of a smooth closing.

Involve Your Accountant: Since much of the documentation necessary for due diligence is financial in nature, consider including your accountant or CFO as early as possible to help prepare. The more cooperation you have from your team, the smoother the process will be.

Designate a Point Person: The point person should be the quarterback during the transaction to orchestrate communication with all parties involved and review all information before it’s released to the buyer. Many professional advisors, such as your accountant, will lose you as a client if the transaction is successful, so they may not be as motivated as you are to close the deal. Being the point person yourself, or appointing someone within the company, will help streamline 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 aren’t required to approve the lease transfer. Delaying the landlord’s involvement can create issues that slow down the closing or prevent it altogether. I recommend involving the landlord as early as possible in the process. 

Prequalify the Buyer: Be sure that you have pre-qualified the buyer before negotiating and accepting an offer. You want to be sure you are 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, be sure to mention it 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 my CPA. I have all the necessary documents ready for due diligence, including tax returns, leases, equipment lists, financial statements, and more.”

It’s vital that you stay engaged and actively involved in due diligence in order to reach your ultimate goal of a smooth closing.

Benefits of Preparing for Due Diligence

If you don’t prepare for due diligence, it can turn into an expensive and time-consuming undertaking. But there are many advantages to preparing for due diligence, and I believe this is a crucial step in selling your business quickly and for peak value. The primary purpose of preparing for due diligence is to address potential problems before placing your business on the market. To attract a sophisticated buyer to your company, you must prepare for due diligence well before you begin the sales process. This is especially true for middle-market companies, as conducting pre-sale due diligence may be the difference between receiving a good price and losing a deal altogether.

Due diligence is one of the most difficult periods of any deal. And the best way for your business to emerge unscathed from this arduous process is preparation. Taking the time to resolve potential issues in your business long before you put it on the market has innumerable benefits. Let’s discuss the major ones. 

Resolve Issues Before They Become Roadblocks

When a buyer decides to pursue the purchase of your business, the buyer will conduct their own due diligence to determine what is going on with your business before they commit to purchasing it. Unexpected issues that arise in the course of the buyer’s investigation may potentially kill a 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 comes into the picture. There’s nothing worse than spending time and money preparing and marketing your business for sale and finding a qualified buyer, only to lose the buyer because of an unforeseen problem with your business that could have been resolved beforehand. This scenario happens 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. For example, issues with financial records, if not addressed beforehand, usually trigger demands for a lower price, more restrictive terms, or may even cause the buyer to walk away from the sale entirely.

Greatly Improve the Odds of a Successful Transaction

Preparing for due diligence allows you to correct potential problems and avoid potential 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 huge disappointment and a waste of valuable time, money, and resources.

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. They will then provide you with a report of their findings. The report helps uncover 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 have a buyer, resulting in a higher chance of closing the deal. This is because a buyer who has issues with your financial records will most certainly conduct due diligence thoroughly to look for problems in other areas, as well.

Maximize Your Sales 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.

Accurate financial records help maximize the sale price of your business by attracting buyers who are confident in your company. Simply put, the more organized your business’s financial records appear, the quicker you are likely to sell your business and receive top dollar.

A thoughtful evaluation of your business before the sale process begins will make the undertaking more manageable, efficient, and cost-effective.

The advantage to preparing for due diligence is you’ll have the opportunity to resolve any issues on your own time, without the added stress of the transaction being dependent on its outcome.

Additional Advantages of Conducting Pre-Sale Due Diligence

Conducting due diligence offers many benefits because it: 

• Prepares your business and management for a sale.
• Helps accelerate the sales process.
• Optimizes the price and structure of a prospective transaction.
• Helps eliminate surprises and any resulting delays during the sales process.
• Gives you a greater ability to control the timing and presentation of information.
• Gives you extra leverage throughout the process because buyers, by contrast, use problems to generate leverage.
• Provides you an opportunity to fix problems and increase the asking price.

Through the process of preparing for due diligence, members of your adviser 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 adviser to prepare a confidential information memorandum and other marketing materials that fully describe and highlight the strengths of your business. Highlighting your business’s strengths and being fully prepared to explain the intricacies will put you in the best position to sell your business at the optimal price.

How to Prepare for Due Diligence

What To Do Before Your Business Is Put on the Market

Preparing your business for due diligence is straightforward. It involves assembling and organizing the documents most buyers request and review during the due diligence period. You should then retain a third-party expert to review these documents and identify any issues the buyer may discover during due diligence. You should then address any issues once they are uncovered. 

The advantage to preparing for due diligence is that you’ll have the opportunity to resolve any issues on your own time, without the added stress of the transaction being dependent on its outcome. The need for having your financial documents prepared and organized – as well as ensuring everything is ready from an operational and legal standpoint – can’t be understated.

Preparing for financial due diligence is one of the most important parts of successfully closing the sale of your business. Because the number one deal-killer of business sales is incomplete or inaccurate financial records, this should prompt you to make it a priority to ensure your financials are in order. Otherwise, you risk losing the buyer because financial inaccuracies will likely be discovered during due diligence. 

No one wants to invest enormous amounts of time with a buyer only to lose them due to something that could have been prevented. Therefore, pre-sale financial due diligence should be conducted by a third party, preferably a CPA. Ideally, this should be performed at least three to six months before beginning the sales process. This will give you ample time to resolve any issues uncovered during the process.

Preparing Documents Before Due Diligence

Preparing your business for sale dramatically increases your chances of success. Laying the groundwork for due diligence helps convince the buyer to agree to a shorter due diligence period and decreases their perception of risk in your business. 

By organizing the documents so they are ready for review, you’ll ensure the process is quick and straightforward. Immediately after you accept an offer, the buyer can start reviewing the documents. Time is your greatest enemy. Time can kill all deals. By preparing for due diligence from the outset, you potentially speed up the process and dramatically improve your chances of closing the deal.

You also increase the chances of receiving an offer. Often, buyers are reluctant to make an offer on a business because they don’t want to risk the time and financial investment in performing due diligence only for there to be an undisclosed problem. Preparing for due diligence mitigates these concerns for buyers.

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

In one recent 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 statements from the bank. This delay resulted in a price concession because the economy took a dip during this time.

You also demonstrate to the buyer that you’re serious when you take the time and effort to prepare your business for sale. Buyers prefer dealing with motivated, prepared sellers. Buyers are more likely to spend time with a seller they know has prepared for the sale.

Key Points

• I strongly recommend you invest time preparing your business for due diligence. Most business owners skip this step altogether. By preparing for this process, you will significantly improve the chances of a successful sale. 
• Demonstrating to the buyer that you have prepared for due diligence increases the buyer’s confidence in your business and reduces their perception of fear. 
• Due diligence can be heaven or hell. If you have your financial documents in order and all is well from an operational and legal standpoint, chances are due diligence will be uneventful. Your business deal will take flight and bring you one step closer to the closing of your dreams. 
• If you are unprepared and the buyer finds things amiss during due diligence, you’ll find yourself on the horns of a dilemma. Being prepared can go a long way in facilitating the outcome you want.