Just as buyers perform due diligence on you and your business, performing due diligence on buyers is also paramount.
One of the most time-consuming yet critical first steps in the sale process is screening potential buyers. The importance of screening buyers cannot be overstated.
The major mistakes most entrepreneurs make during the early phases of a transaction are wasting energy on buyers who aren’t qualified and judging the attractiveness of an offer without first obtaining background information on the buyer.
Before you invest time and energy in negotiating with prospective buyers, you first want to establish that they are motivated and financially capable of purchasing your business. Doing so will help ensure you are negotiating with a qualified buyer and motivate you to invest more energy into the process.
Most buyers who aren’t serious won’t go to the trouble of completing a detailed buyer profile and personal financial statement, so the screening process itself will help weed out tire kickers. Once the buyer submits an offer, they should submit source documents to verify their financial ability to complete the transaction, which will allow you to screen the buyer more thoroughly.
Don’t waste your time and energy on buyers who are not qualified.
Part of your initial due diligence is to assess the buyer’s motivation. When dealing with potential buyers, ask yourself:
- How motivated does the buyer appear?
- Do they quickly return your calls and emails?
- Are they eager to move forward, or do they seem overly critical? Overly critical buyers usually do not have serious intentions of buying a business.
The process may change slightly depending on whether the buyer is an individual, a company, or a private equity group. The process for screening an individual is different from screening a company.
We answer the following questions in this article:
- What is a phased screening process?
- What is the first step in screening a buyer?
- How long does it take to close once you find a buyer?
- When should tax returns and bank statements be shared with buyers?
- What should you do if a buyer refuses to be screened?
- Should you accept a verbal assurance from a buyer that they are financially qualified?
But first, let’s take a look a more detailed look at why you as a seller should perform due diligence on prospective buyers …
Table of Contents
- Reasons for Screening Buyers
- Use a Phased Screening Process
Reasons for Screening Buyers
- If you are financing a portion of the sales price, you should screen the buyer just as any bank would.
- You want to ensure they will qualify for the lease and don’t want to waste their time. The seller may also remain on the lease as a guarantor, in which case the seller may want to ensure the buyer is qualified and will not default on the lease.
- You want to be sure they meet any requirements for a franchise, license, or any other qualifications required by third parties.
- You want to verify that the buyer has the cash down payment before investing significant time or money in performing due diligence. Due diligence is a serious commitment for a seller and can cost the seller thousands or tens of thousands of dollars in professional advisor fees paid to attorneys, accountants, and other third parties. Any prudent seller will want assurance that the buyer has enough cash to complete the transaction before they make this investment.
- Even if the buyer is paying all cash and no third-party approvals are required, fraud and theft are still a risk for any seller. The seller will be giving the buyer access to highly sensitive information, such as bank statements and tax returns. Screening the buyer gives sellers confidence they are dealing with a legitimate party.
Use a Phased Screening Process
A phased screening process involves screening buyers in phases or stages. This is necessary because most buyers will refuse to be thoroughly screened at the initial stages, particularly before seeing information on the business and deciding they would like to take a closer look.
For example, if you were to ask a buyer for a financial statement, bank statements, tax returns, and other documents early in the process, most would refuse. The solution is to ask the buyer for this and other qualifying information in stages as the buyer progresses through the steps in buying your business.
Releasing information in phases saves time, preserves confidentiality, and ensures that unqualified buyers are not provided information about your business.
Our first step in determining if they are serious is to ask the buyer to sign a non-disclosure agreement (NDA), buyer profile, financial statement, and disclosure statement. Once buyers have completed these documents, they will then have access to the confidential information memorandum (CIM).
If the buyer is interested once they review your CIM, they may:
- Request to meet you personally.
- Request additional information (e.g., financial statements) prior to meeting you.
Should the buyer decide to make an offer, they may also have to disclose more detailed information about themselves, including a detailed financial statement, buyer disclosure agreement, bank statements, tax returns, etc.
Most of this information is provided after an offer has been accepted, but some is provided before if the seller is financing a portion of the purchase price. Doing so allows the seller to evaluate the buyer’s creditworthiness before committing to a seller note.
When selling a business, the process looks like this:
- The buyer signs a non-disclosure agreement (NDA), buyer profile, financial statement, and disclosure statement.
- The buyer receives the CIM.
- The buyer requests additional documents, such as financial statements, on the business or requests a meeting with the seller.
- The buyer submits a letter of intent (LOI).
- The seller reviews the buyer’s information and accepts, rejects, or counters the offer.
- If the offer is accepted, due diligence begins, and a further mutual exchange of information ensues. For example, the seller may perform a background check on the buyer, hire a professional to investigate the buyer (if the seller is carrying a note), or request other financial documents (sometimes required if the seller or bank is carrying a note).
Should I immediately send the CIM to a buyer once they sign the non-disclosure agreement?
Yes, we recommend initially sending the CIM to buyers. Buyers expect to see this immediately after signing the NDA and will often ignore your emails if they don’t immediately receive a professionally prepared package on your company right off the bat.
How long does it take to close once I find a buyer?
It takes two to four months to close, on average, once an LOI is accepted. We have closed some transactions in as little as one month, and others have taken more than six months to close. It generally takes one to two months for due diligence and another one to two months to close once due diligence is complete. The process can take longer if third-party financing is involved or if complications arise during the process.
What should I do if a buyer requests tax returns?
Tell the buyer that tax returns, bank statements, and other sensitive documents will be released only after an offer is accepted, during the due diligence period.
Should I deal with a buyer who refuses to be screened?
Don’t waste your time with this type of buyer. Remember, the sales process is long, so you want someone flexible and realistic to work with, not just someone who will pay your price. These buyers usually end up trying to bargain for much more than they initially agreed on, and most deals with the “buyer from hell” end up falling apart. They often threaten lawsuits, threaten to leak word of the sale to competitors, and more. Don’t waste your time with them, plain and simple. Find someone who is easier to work with and who is cooperative enough to get a deal done. Remember, all transactions require cooperation from both the buyer and seller. If you encounter a buyer who seems exceptionally rigid in their strategy, you should move on.
What if the buyer refuses to complete a financial statement or provide information?
This is a red flag. Don’t waste your time with this buyer. The majority of the time, it isn’t advisable to provide information to any buyer who refuses to provide any information about themselves. Even if they are qualified, refusing to complete a simple form makes them uncooperative, and it’s difficult to progress with the transaction with uncooperative buyers.
Should I accept a verbal assurance from the buyer regarding their qualifications?
You can ask the buyer verbally how much they have to invest, their credit score, and their net worth, but you should obtain these answers in writing as early in the process as possible.
Do you recommend we verify the information on the NDA?
No. Based on our experience, a small number of buyers provide inaccurate information, so verifying each buyer’s information is impractical and will likely scare buyers away this early in the process. The screening process involves releasing information to the buyer in phases. This means that as you release more information to the buyer about your business, you will also request information from the buyer, which will provide you with an opportunity to verify their information.
Can’t the buyer just lie on their financial statement?
Few serious buyers do this, especially if you ask them to sign the document. When an offer is made, you may ask to see source documents such as bank statements. Buyers know that their representations are verified in the process, and few will falsify this information.
Are there any other methods I can use to research the buyer?
Google their name, phone number, and email address to see if anything interesting shows up.
The buyer said they have an investor. What should I do?
Ensure the investor is also pre-screened since they will have access to confidential information on your business. The investor should sign the NDA and also fill out the qualification forms.
I called and emailed the buyer, and they didn’t respond. What should I do? How many times should I follow up?
You should not have to chase a buyer. We recommend following up a maximum of two or three times. A buyer must be sufficiently motivated to go through the process and has plenty of opportunities to change their mind, so don’t chase them down. If you have to chase a buyer or “push” them through the sales process, it’s unlikely they will follow through to closing the sale.
What is the number one piece of advice you would give me when dealing with buyers?
Run your business as if you are never going to sell it. Never get hung up on one buyer. It’s easy to get wrapped up with one buyer so much that you lose focus on the business, and revenue begins to slide. Invest time in the buyer but not emotions. Spend time with the buyer, give them what they need, treat them with respect, but stay focused on running your business until the closing.