Navigating Due Diligence: What to Expect When Selling Your Business
Selling your business is one of the most significant transactions you will undertake, and the due diligence process is a pivotal part of that journey. For buyers, due diligence is the process of verifying the financial, operational, and legal aspects of your business to assess its value and risks. For sellers, it’s an opportunity to demonstrate transparency and build trust with prospective buyers.
This white paper provides a detailed breakdown of the buyer’s due diligence process and offers actionable advice for navigating it with confidence, ensuring a smoother transaction and maximizing your business's value.
1. What Is Due Diligence in M&A?
Due diligence is the comprehensive review and verification process conducted by the buyer to confirm the details provided by the seller. It helps buyers assess risks, validate assumptions, and ensure the business is a sound investment.
Goals of Due Diligence:
Verify financial performance and projections.
Identify legal, operational, or market risks.
Confirm the valuation and deal structure.
While it is often thorough and time-intensive, a well-prepared seller can expedite the process and reduce friction.
2. The Main Areas of Due Diligence
A. Financial Due Diligence
Financial due diligence is the cornerstone of the buyer’s evaluation process.
What Buyers Review:
Financial Statements: Profit and loss (P&L) statements, balance sheets, and cash flow statements for the last 3–5 years.
Tax Records: Federal, state, and local tax returns to ensure compliance.
Normalized EBITDA: Adjustments for owner perks, one-time expenses, or non-recurring revenues.
Accounts Receivable and Payable: Aging reports to assess cash flow and customer payment trends.
Seller Preparation Tips:
Organize all financial records in advance and reconcile any discrepancies.
Address outstanding tax issues to avoid red flags.
B. Operational Due Diligence
Buyers need to understand how your business operates on a day-to-day basis and whether it can sustain profitability post-sale.
What Buyers Review:
Processes and Systems: Operational workflows, supply chain reliability, and key systems.
Employee Structure: Organizational chart, key personnel, and employee contracts.
Customer and Supplier Relationships: Contracts, customer concentration, and supplier agreements.
Seller Preparation Tips:
Document processes and standard operating procedures (SOPs) to highlight scalability.
Mitigate risks like over-reliance on key employees or customers.
C. Legal Due Diligence
Legal due diligence ensures there are no outstanding legal liabilities or compliance issues that could impact the business.
What Buyers Review:
Business licenses, permits, and regulatory compliance.
Litigation history, ongoing lawsuits, or disputes.
Intellectual property (IP) ownership, including patents, trademarks, and copyrights.
Contracts with customers, suppliers, or employees.
Seller Preparation Tips:
Resolve any ongoing legal disputes before entering due diligence.
Ensure all contracts and agreements are up-to-date and legally enforceable.
D. Market Due Diligence
Buyers will assess the external factors impacting your business, such as market trends and competitive positioning.
What Buyers Review:
Industry growth trends and market size.
Competitive landscape and your unique value proposition.
Risks such as regulatory changes, shifting consumer behavior, or economic downturns.
Seller Preparation Tips:
Provide market research or reports that highlight opportunities for growth.
Emphasize your competitive advantages, such as intellectual property or brand strength.
E. IT and Technology Due Diligence
Technology plays a critical role in modern businesses, and buyers will evaluate your IT infrastructure for scalability and risks.
What Buyers Review:
Hardware, software, and cybersecurity systems.
Data privacy compliance, especially for businesses handling sensitive customer information.
Technical debt or outdated systems that may require costly upgrades.
Seller Preparation Tips:
Invest in cybersecurity measures and ensure compliance with data regulations.
Provide a detailed inventory of all IT assets and licenses.
3. How to Prepare for the Due Diligence Process
A. Create a Virtual Data Room (VDR)
A VDR is a secure online platform where you can share documents with prospective buyers during due diligence.
Benefits:
Enhances organization and accessibility of documents.
Tracks document access and protects sensitive information.
B. Conduct a Pre-Sale Due Diligence Audit
Consider hiring an advisor to perform an internal due diligence review before engaging with buyers.
Benefits:
Identifies and addresses potential red flags.
Ensures all documents are accurate and complete.
4. Common Challenges During Due Diligence
A. Incomplete or Disorganized Records
Failure to provide complete or accurate information can delay the process or erode buyer trust.
Solution: Proactively organize documents and address gaps before the due diligence process begins.
B. Surprises or Inconsistencies
Buyers may uncover issues such as unresolved tax liabilities or customer churn that weren’t disclosed earlier.
Solution: Be transparent about any risks and work to resolve them before due diligence.
C. Confidentiality Concerns
Sharing sensitive information can expose the business to risks if the deal doesn’t close.
Solution: Use NDAs and secure data-sharing platforms to protect your information.
5. What Happens After Due Diligence?
Once due diligence is complete, buyers will typically adjust their offer based on their findings.
Possible Outcomes:
No Change: The buyer proceeds with the deal as originally proposed.
Revised Terms: The buyer may adjust the purchase price or deal structure to account for identified risks.
Deal Termination: In rare cases, significant risks may cause the buyer to walk away from the transaction.
Sellers who are well-prepared can reduce the likelihood of negative outcomes and maintain leverage during negotiations.
Conclusion: Navigating Due Diligence With Confidence
The due diligence process is an essential part of selling your business. While it can be intensive, thorough preparation, organization, and transparency can help streamline the process, build buyer confidence, and protect your business’s value.
Take Action Today: Consult with an M&A advisor to conduct a pre-sale audit and create a detailed due diligence plan. With the right preparation, you can navigate the process with confidence and achieve a successful outcome.