Sellers of a business need to do a lot to prepare for the sale. Along with looking for the right buyer, they should begin planning for the due diligence process well before they list the business for sale. This can help make sure they’re prepared once they do find a buyer, as everything can move quickly after that point. Failing to be prepared slows down the entire process and can mean the loss of a sale. So, how does a seller prepare for the due diligence process?
What is Due Diligence and Why is it Important?
Due diligence is the process in which the buyer and seller review all information about the business to determine if the buyer thinks it’s something they should purchase. Both buyers and sellers can request information from each other and can review the information to determine if the sale should move forward. Most information, however, will be requested by the buyer as they need to ensure they are purchasing the right business for their interests. It is somewhat like purchasing a used vehicle, where the buyer will have a mechanic do a thorough inspection before the purchase to minimize the potential for expensive surprises.
The due diligence process can have a huge impact on whether the sale goes through and how much the business sells for. When a seller is preparing for the due diligence process, they will go through every part of their business carefully to ensure everything is ready. If they find any potential issues, such as liens that have not been removed or key contracts that have not been executed yet, they can fix these issues before the buyer discovers them. This ensures everything is ready to go when the business is listed for sale and minimizes things the buyer might notice that could lead them to request a lower purchase price for the business.
How Due Diligence Works
The due diligence process is done after the buyer shows interest in purchasing the business, but before the purchase is complete. During this time, the buyer will request information from the seller so they can evaluate the value of the business and determine if it’s the right business to purchase. The documents requested can vary depending on the type of business and the buyer, but the seller should have as much as possible prepared in advance to speed up this part of the buying process. Once the due diligence is done, the buyer may adjust the amount they’re willing to pay for the business or adjust some of the terms of the sale based on what they found during the due diligence process.
Preparing for the Due Diligence Process
Sellers, as noted, should begin preparing for the due diligence process before they list the business for sale. This allows them to minimize any potential issues that could impact the sale of the business. To prepare, sellers should gather all of the documents they believe will be requested or needed during due diligence and ensure they’re organized and ready for the buyer to review. The exact documents needed can vary, depending on the type of business and what the buyer wants to know, but there are standard components that the seller can begin going through to prepare for the sale.
The seller should also take this time to find the professionals they will want to work with through the due diligence process so they can have assistance with obtaining and sharing any necessary documents. This allows them to have the assistance they need through the process, so they don’t have to handle it on their own. When they have the right help, they can continue focusing on managing the business, so there are no issues because of the due diligence process.
General Categories for Due Diligence
Though the seller cannot predict everything the buyer will want to review, they can start organizing information that the buyer is likely going to need during the due diligence process. There are several categories that the seller should look into and gather any documents for. These categories include the following.
· Organization and Operations – The buyer will need to know how the business is organized. This includes formation documents, board minutes, any equity agreements, ledgers, and other information that shows the structure and organization for the business.
· Financial Records – Buyers need all financial information for the business, including balance sheets, income statements, audit reports, and tax documents.
· Any Contracts – Any contracts that will still be in force after the sale should be shared with the buyer. This could include customer contracts, vendor contracts, loans or other financial contracts, and employee contracts.
· Litigation or Regulations – Any permits obtained by the company as well as pleadings for pending litigation or notices of threatened litigation should be shown to the buyer during due diligence.
· Employment Information – Buyers will need information about current employees, including their wages, benefit plans, bonuses, and any benefit policies that may be in effect.
· Any Intellectual Property – Information about intellectual property owned by the business, including copyrights, trademarks, or patents, should be shared with the buyer.
· Marketing Information – Buyers should be able to review current marketing information to help them determine how marketing is currently being done and what they might want to start if they purchase the business.
Common Documents Requested by Buyer
Though the buyer can request just about any documents they may need to decide to buy the business, there are standard documents that they will request. When the seller is getting everything ready, they may want to make sure they have the following documents prepared.
· Financial Statements – Buyers will want full access to financial statements to make sure they understand how the business has performed previously, how it is performing now, and how it may perform in the future. They’ll look for anything that seems out of place or unusual.
· Any Accounts Receivable – Potential buyers will want to look for accounts that are more than a few months old, any write-offs they may need to worry about, and check for potential allowances for bad debts that might be their responsibility if they purchase the business.
· Current Inventory and Inventory History – The buyers will want to see the current inventory for the business as well as look into how quickly the inventory typically moves. They’ll want to see what the typical turnover rate is as well as look into the pricing practices for the business and any depreciation methods used.
· Any Contracts and Licenses – Any contracts will need to be reviewed by the buyer as well as leases, vendor agreements, and any agreements with consumers. They will also want to look at any permits or licenses the business holds to make sure everything is legally operating.
· Full Tax Returns for Prior Years – Buyers will want to check out whether there are any net operating losses for the business or other tax implications that they will need to be worried about if they take over the business.
Due Diligence for the Seller
Most of the due diligence is for the buyer to make sure they are getting a good deal on the business and purchasing a business that’s right for them, there is due diligence for the seller as well. They should take this time to do their research so they can make sure they have found the right buyer for the business. They may want to look into the visions the buyer has for the company to ensure it matches their own or check to make sure the business is going to continue to grow and be profitable once it has sold. If the seller will be merging with the buyer instead of selling outright or will be owning stock in the company after it has sold, this information becomes crucial so they can ensure they will continue to bring in profits after the business has sold.
Common Documents Requested by Seller
During the due diligence stage, there are some documents commonly requested by sellers from the buyer. The seller should request these at the beginning of the due diligence process so they can ensure they receive all documents they need promptly and to allow for time to obtain other documents if they find they need further information before the sale.
· Financial Statements – The seller will want assurance that the buyer is capable of purchasing the business. Financial statements from the buyer will show that the money is available for the purchase of the business.
· Buyer’s Contracts – Sellers may want to check any contracts the buyer currently has to ensure nothing will be an issue after the sale and to make sure the contracts will not impede the purchase in any way.
· Authorization for the Purchase – If the buyer needs to be authorized to make the purchase, the seller should ensure that the proper authorization has been obtained. Without this, the sale will not go through.
· Authorizations to Sell Stocks – If the seller will be given stocks in the business as part of the sale, they need to make sure the buyer will have the authorization to provide them with the stocks. They should get this information during the due diligence process, so there are no surprises after the sale.
· Other Documents – Depending on the details of the sale, there may be other documents the seller will need to look at during the due diligence stage. They should ensure they know what these documents are and be ready to request them during this process, so everything is available to them before the sale proceeds.
Preparing the Documents for the Buyer
During the due diligence period, the buyer will give the seller a list of the documents they need. At this point, the seller should take the time to prepare each of the documents for the seller to review. The seller needs to ensure everything is properly organized and that all documents are ready. The seller should already have several documents ready, as they should have the items listed here prepared in advance. They can then gather any information they did not already have ready and work on organizing the information so it can be presented to the buyer.
The seller will want to organize the information based on the request list for the buyer. This ensures they have everything and makes it easier for the buyer to find everything they’re looking for. It also makes it less likely that the buyer will request information they already have since the information is all organized in the order requested by the buyer.
How to Share Documents Securely
Many times, due diligence for a business sale is done by presenting physical copies of all documents. However, it can be expensive to produce physical copies of every document, and having all of the physical copies is not very secure. It also means the buyer needs to visit the office during business hours to be able to view the documents. Instead, documents can be shared securely through a virtual data room.
All of the documents needed during the due diligence process can be uploaded to the virtual data room so they can be accessed whenever it’s convenient for the buyer and the seller. The buyer is free to access the documents after business hours as well as in a location that’s convenient for them. All documents are kept secure and only viewable by those who are authorized to view them, and the documents are fully indexed for convenience as well as easy to view without new software needing to be purchased or installed.
If you’re planning on selling your business, the due diligence process is crucial and needs to be handled carefully to avoid any potential issues. Make sure you have the documents here prepared so the buyer can start reviewing over them while you obtain any other necessary documents. If you’d like to make the due diligence process as smooth as possible, consider using a virtual data room that enables you to share documents with the buyer securely and conveniently.