Here’s What to Expect During Due Diligence When Selling Your Business

Due diligence might seem mundane or tedious at first glance, but it’s a critical step to successfully closing the deal when selling your business. In some cases, it can be one of the most difficult and stressful stages of the selling process. However, by knowing what to expect and planning ahead, you can take proactive steps to avoid common pitfalls and help ensure the process runs smoothly and the deal closes.

In this article, we discuss several aspects relating to due diligence from the seller’s point of view. These include:

• Understanding how due diligence works when selling your business
• Steps you can take to help ensure everything goes smoothly
• How to decide whether or not you should seek legal help during due diligence

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Understanding Due Diligence When Selling a Business

If this is your first time going through the exit process, you may be wondering, “What is due diligence when selling a business?” Understanding due diligence is the first step in learning how to create a smooth and successful process. 

“Due diligence provides the buyer with the opportunity to verify the accuracy of all information related to the business.”

What is due diligence?

Selling a business involves many separate stages. Due diligence is a crucial stage that comes after the letter of intent has been signed and before the asset purchase agreement is finalized.

The letter of intent spells out the terms and conditions of the sale. At this point, however, the potential buyer has not had an opportunity to verify the seller’s claims about the business. They have been operating under the assumption that the seller is telling the truth. 

Buying a business likely represents a significant investment for the buyer. Before the business acquisition is finalized, the buyer must verify the seller’s claims about the business. Due diligence provides the buyer with the opportunity to verify the accuracy of all information related to the business.

During proper due diligence, the buyer and their team go through the seller’s business records and third-party accounts thoroughly. This makes it an exhaustive process that involves extensive data gathering and analysis.

But while the process may seem geared toward the buyer, this period also provides benefits to the seller. As more clarity and assurance are created, the chances of disagreements occurring after the sale go down. 

It can be helpful to conceptualize the process as focusing on several main aspects. These include:

• Financials
• Vendors
• Documentation
• Key reports

Financial due diligence

The buyer must be able to verify the financial performance of your company during the due-diligence process. In practice, this usually requires being able to re-create the profit and loss statement for at least the previous 24 months. 

The buyer must be able to do this using information from third-party sources, as opposed to going off of accounting records or financial statements. The use of third-party statements is necessary in order to ensure that records are non-falsifiable.

Third-party sources may include:

• Bank statements
• Vendor invoices
• Seller account records (such as Amazon statements or Shopify statements)
• Merchant charge statements
• Tax returns or any other legal documents

Vendors and contractors

Your business likely has agreements with a range of vendors or contractors. These may include your suppliers, software vendors, fulfillment centers, or any other entity with whom you have entered into a contract. 

Your buyer has an interest in maintaining the same (or better) contract with each vendor once they take over ownership. However, your vendors may try to renegotiate the terms once they learn that your business is being sold. 

As such, the buyer will want to explore and verify all of your vendor relationships. In addition, they will want to ensure they receive the same terms, discounts, and deals that you currently have with your vendors or contractors. 

Documentation and legal considerations

A responsible buyer will want to ensure that all of your documents and registrations are in order before proceeding with the sale. This may include examining your articles of incorporation, business registration, and more. This process is often referred to as legal due diligence. 

In addition, they will work to investigate whether or not your business has any current or potential legal issues that would transfer to a new owner. 

Key reports

You may have provided the prospective buyer with certain reports about your business’s key performance indicators or other relevant information during the initial phases of negotiations. Be prepared to provide third-party information to verify these reports during the due-diligence process. 

“Your buyer has an interest in maintaining the same (or better) contract with each vendor once they take over ownership.”

What Happens during the Due-Diligence Phase

Many entrepreneurs who have not been through the exit process before wonder what happens during the due-diligence phase of the sale of a business. Knowing what to expect going into the process can help you navigate it more successfully.

During the due-diligence period, the buyer may be working with a business Advisor, a team of lawyers, or a firm that specializes in conducting the process. This is to help ensure that the buyer obtains and analyzes all relevant information prior to completing the transaction.

The buyer and their team will request certain information from you throughout the process. It is your job to provide them with the requested information and answer any questions they may have. This may include access to third-party accounts and proof of bank statements. This will help the buyer have confidence in the verification process. 

Generally, the process is pretty in-depth for both the buyer and the seller. It requires a lot of work and time and can often be a stressful experience. As the seller, you will be communicating with the buyer frequently throughout the process in order to address their concerns and keep the process moving forward. 

Due-diligence checklist

Buyers will often prepare a due-diligence checklist ahead of time and provide it to you once the process starts. This list contains all of the information they feel they need in order to adequately verify your business. They may have prepared this list with the help of a broker, accountant, or hired due-diligence advisor. 

Common items on a due-diligence checklist can include:

• Seller account statements for the previous 24 months
• Bank statements for the previous 24 months
• Vendor invoices for the previous 24 months
• Vendor list containing contact information for each vendor

It is your job to provide them with all information they request on the list, within reason. As the process unfolds, the buyer may request additional information, such as proof of working capital or cash-flow statements. 

“As the seller, you will be communicating with the buyer frequently throughout the process in order to address their concerns and keep the process moving forward.”

Dealing with sensitive information

You and the buyer will have signed a non-disclosure agreement at the beginning of the sales process. However, due diligence often reveals sensitive business information that may pertain to a business’s competitive advantage. As a result, some sellers can be hesitant to disclose certain details until absolutely necessary. 

The due-diligence process often starts with covering areas that are less sensitive and have the greatest potential to derail the transaction. Once these areas have been satisfied, you have more assurance that the deal has the potential to move forward. This can help you be more open to revealing sensitive information. 

Sellers are often most hesitant to reveal information regarding their suppliers and vendors. Depending on your position, you may prefer to disclose these relationships toward the end of due diligence.

Tips for Creating a Successful Due-Diligence Process As a Seller

As the business owner, there are several things you can do to create a smoother and more successful due-diligence process. These include:

• Preparing your documentation
• Staying organized
• Communicating effectively
• Addressing discrepancies promptly and fairly

Preparing your documentation

A huge amount of data must be collected, organized, and analyzed before closing the deal. Preparing your documentation beforehand saves valuable time and creates a much smoother process. 

Whether it’s lease agreements, supplier contracts, articles of incorporation, or financial statements, the work you put into preparing these documents beforehand will pay dividends in the long run.

Staying organized

The more organized you are the better able you will be to navigate the due-diligence process. Being organized helps you be better prepared to provide any requested information and answer any questions that arise. 

Communicating effectively

Good communication is essential throughout the sale process, but it is especially important during due diligence. Good communication involves:

• Responding to correspondences in a timely manner
• Answering questions thoroughly
• Listening well
• Negotiating fairly 

Addressing discrepancies promptly and fairly

As the buyer combs through your records, they may identify discrepancies between the information you reported and what can be proven by tracking your third-party accounts. Some discrepancies may be small, and others may be larger. If this happens, the buyer may wish to revise their initial offer or adjust the sale price based on the new information. 

For example, the discrepancy may change the information upon which your business valuation is based. In this case, there may be grounds for renegotiating the terms.

When this happens, be sure to respond to their concerns in a prompt and fair manner. You can choose to accept their new offer, make a counteroffer, or stick to the prior agreement. Keep in mind, however, that the buyer can decide to walk away from the deal based on this new information.

“As the buyer combs through your records, they may identify discrepancies between the information you reported and what can be proven by tracking your third-party accounts.”

Should You Seek Legal Help during Due Diligence?

Due diligence is both complex and important. As a result, most business owners find it helpful to work with a qualified business Advisor or broker. Your Advisor can help you negotiate more effectively and facilitate the transfer of key information. They can also help keep your sensitive information, such as supplier details or intellectual property, confidential until absolutely necessary. 

Depending on the qualifications of your business Advisor, you may also consider hiring outside legal help. Effective due diligence is often a team effort. Hiring a lawyer can help you navigate the legal ramifications of the due-diligence process, but it is not always necessary. 

As you get closer to the due-diligence phase, you and your Advisor can decide whether you would benefit from bringing a legal advisor on board as well.