7: Conduct Due Diligence

Summary of the Process

A) Send us your due diligence list
B) We prepare the Master Due Diligence List and data room
C) The parties conduct due diligence

You will begin conducting due diligence immediately after the seller accepts your letter of intent (LOI). While due diligence is designed to limit your risk, you can never be absolutely assured any business is risk-free as all businesses inherently have some risk. The purchase agreement will include clauses (i.e., representations and warranties) designed to protect you in the event due diligence doesn’t uncover all material issues regarding the business. In most circumstances, you can walk away from the transaction if you’re unsatisfied for any reason during due diligence, and your earnest money deposit, if applicable, will be refunded.

A) Send Us Your Due Diligence List

If your LOI has been accepted, please send us your due diligence list so we can begin preparing the data room as quickly as possible.

We strongly recommend not downloading a due diligence template from the internet and sending it to us. Long due diligence lists with a significant number of irrelevant requests send the wrong message to the seller. We also recommend you do not request the seller to prepare any new documents, such as a business plan, if they don’t currently have one. Due diligence should be a review of the seller’s existing documents and should not require the seller to produce new information.

Sample Due Diligence List

The following information is customarily only released after a letter of intent is accepted, during the due diligence period:

Assets

• Equipment inspection reports
• Equipment leases
• Equipment values
• Detailed inventory and equipment lists

Financial

• Accounts receivable aging schedule
• Accounts payable summary or reports
• Balance sheets older than three years
• Bank statements
• Cash flow statements
• Federal income tax returns
• Financial budgets and projections
• General ledgers
• Inventory reports
• Invoices and receipts
• Profit and loss statements older than three years
• Sales and use tax reports
• Tax returns

HR

• Employment, agency, and independent contractor agreements
• Staffing and payroll-related documents, including job descriptions and employment contracts

Legal

• Copies of existing loan or financing agreements
• Copies of key contracts
• Environmental documents and inspections
• Licenses and permits
• Third-party contracts, such as supplier or vendor contracts

Operations

• Operations manual
• Supplier and vendor list

Real Estate

• Annual personal property tax certificate(s)
• Premises lease

Sales & Marketing

• Marketing, advertising, and promotional documents

Third-Party Documents

• Franchise-related documents such as franchise agreements, franchise disclosure documents, etc.
• Insurance-related documents such as workers’ compensation, health, and liability insurance

B) We Prepare the Master Due Diligence List and Data Room

Once we receive your due diligence list, we will begin gathering, organizing, and uploading the documents you requested to an online data room. We also prepare a Master Due Diligence (MDD) List, which is the primary document the parties use to track outstanding requests, questions, status, and other important information regarding the due diligence process. The Master Due Diligence List allows all parties to simultaneously work on the document, which streamlines the process by eliminating duplicate copies and enables accurate tracking of all outstanding requests. It’s absolutely essential that the parties understand how to use the MDD Checklist and that they use it on a regular basis to ensure the process is organized and that all outstanding requests are kept up to date.

Once the MDD Checklist is prepared, we arrange a kickoff meeting to walk the parties through the MDD Checklist, the data room, and the due diligence process. Please ensure you’re in front of a computer during the kickoff meeting so we can walk you through how to use the MDD Checklist. If you have any partners, employees, key advisors (e.g., accountants or attorneys), or anyone else directly involved in the transaction, we recommend they attend the kickoff meeting so they’re familiar with the due diligence process.

C) The Parties Conduct Due Diligence

You may begin reviewing documents as we upload them to the data room. You can note any questions you have regarding any documents in the MDD Checklist.

In certain circumstances, due diligence may be mutual, and you’ll be requested to provide the seller with a copy of your credit report, bank statement, background check, and other documents. This may occur in the following scenarios:

• If the seller is financing a portion of the sale
• If the seller is retaining equity in the business
• If the seller owns the property and will lease you the premises post-closing

The following are tips for conducting due diligence:

• Document Review Prioritization: We recommend prioritizing key documents (e.g., financial statements, contracts, employee agreements) to ensure you address the most critical aspects of the business early in the due diligence phase.
• Regular Check-ins: Schedule regular check-ins (e.g., weekly) to track progress, ensure requested documents are being uploaded on time, maintain momentum, and make sure important details aren’t overlooked.
• Specific Questions List: As you progress through due diligence, keep a list of specific questions on the Master Due Diligence List. This way, you can organize your inquiries based on the category of information (e.g., financial, legal, operational), ensuring focused conversations and reducing confusion.
• Engage Your Advisors Early: Involve your legal, financial, and operational advisors early in the due diligence process. This way, any issues can be identified early in the process, and experts can help assess the accuracy of the information provided.
• Calls vs. Emails: Calls are ideal for complex discussions or when a back-and-forth conversation may be necessary. Emails should be used for simple questions or requests for clarification on specific items that don’t require detailed back-and-forth conversations.
• Best Practice: Start with emails to pose specific questions or ask for clarification. If the question requires a detailed response, schedule a call to address any follow-up questions or concerns.

Tips for Conducting Due Diligence

Speeding Up Due Diligence

Making yourself more available to the seller for queries and clarifications can shorten the due diligence period. It’s also critical to quickly raise any areas of concern you may have so they can be immediately addressed, which can prevent delays.

Understand the Role of Representations and Warranties

Representations and warranties are statements and guarantees by the seller relating to the assets, liabilities, and other elements of the business being sold. Representations and warranties (reps & warranties for short) are included in the purchase agreement and assure you that legal remedies are available if the seller fails to disclose any key facts regarding the business you don’t discover during due diligence. If these statements prove to be false, you’re entitled to seek remedies, which could result in the seller paying you for damages. Representations and warranties, therefore, relieve you of the responsibility to perfectly perform due diligence as remedies will be available to you if the seller fails to disclose material facts regarding their business during the due diligence period.