Why is “Due Diligence” Crucial When Buying or Selling A Business?

If you’re preparing to sell your business, it’s vital to understand the importance of Due Diligence.  Since most small business owners sell only one company in their lifetimes, it is difficult to get their arms around the Due Diligence process. After all, their expertise resides in running the business they have built over time, not in the intricacies of selling a company. Notwithstanding such, it can yield big dividends later if you take time to learn more about the process and what information potential buyers will expect you to produce before going forward with the deal.

PART I – BUYERS

Exactly What is “Due Diligence”?   “Due diligence” refers to the verification and  information gathering process whereby a buyer seeks to validate their decision to buy a business.  This step occurs prior to the actual closing of the sale.  This is a crucial step in that the information gained in the process helps the buyer verify financials, review the quality and accuracy of revenues and ensures that the company’s past and potential opportunity for growth syncs up with what the buyer’s expectations are or what were set forth in the Letter of Intent (LOI). Small business owners can typically expect this process to last anywhere from 2 to 4 weeks on the average.

Depending upon the particular business, the acquirer may seek information, request documentation and conduct interviews pertaining to a variety of concerns during the Due Diligence process.  These items may include, among other things: management bios; financial statements; business/corporate records; financing in place; existing key contracts; customer base information; sales forecasts; marketing and sales materials; operations processes and programs; employee information; intellectual property; tax information and legal documents to name the primary areas of concern.

How To Conduct  Due Diligence.   When conducting Due Diligence, the buyer is looking for any information to shed light on any possible liabilities that they could potentially assuming upon purchase. The existence of such liabilities could significantly alter the valuation placed on the company by the parties and require a re-evaluation prior to closing.

Apart from evaluating liabilities, buyers will also analyze opportunities for future business revenue to ensure the value they have placed on the company’s potential earnings is accurate.  Many would-be buyers are looking for insight to help ensure that the company’s business operations, personnel and processes would provide a good fit with their own organization.

PART II – SELLERS

How Does Due Diligence Differ When Selling a Business? The Due Diligence process can be equally important to sellers of businesses since it empowers them with  the information necessary to determine a realistic valuation for their business. It is recommended that Sellers perform their own internal Due Diligence prior to opening their books to potential buyers. It’s especially important at this time to help uncover and rectify any unresolved tax, legal or regulatory issues that could complicate or kill a potential sale.

If there are any outstanding concerns, the seller should consult with their legal counsel or other professionals regarding when and how to present these issues to the buyer. Sellers should be upfront with buyers early on and never try to hide problems as such almost always comes back to haunt you later on.  Buyer’s never like to be surprised during the Due Diligence process.

Due Diligence Tips For Sellers.  As Due Diligence can be an intense process, sellers should keep the following considerations in mind;

  1. While it may be difficult, don’t take it personally when a prospective buyer scrutinizes how you have conducted your business in the past.
  2. Continue running your business as usual through the process. If you don’t, you might risk a sudden dip in sales or get behind on paying suppliers, which could complicate or compromise the closing.
  3. It is in your best interest that the Due Diligence process doesn’t needlessly drag on.  Be organized from the get-go, and do your best to respond to questions and information requests in a timely manner.
  4. Confidentiality is critical at this stage in the game (you don’t want to alert employees or customers that a deal is in the works), so sellers should only share their plans with key employees on a need-to-know basis. You should also be prepared to respond to inquiries should there be an inadvertent leak of the sale.
  5. Assign a person to represent your company and field inquiries during the Due Diligence phase. Assigning one point of contact to manage Due Diligence requests can greatly simplify the process and help maintain order.
  6. You need to be able to rely on your professional advisers (legal, tax, accounting, personnel, investment bankers) during the Due Diligence guidance. The Due Diligence process is complicated, especially if you don’t have experience selling a company. You can save yourself time, headaches and a low valuation if you engage an investment banker who has experience overseeing due diligence with companies like yours.

Let Klein Law Corporation help you through the Due Diligence process or in connection with the sale or purchase of a business. Contact us at 949-860-7433 or click here to send a message.