Closing the Deal: Part 2 – Due Diligence
In Closing the Deal: Part 1, we covered the main stages of the deal process. In this article, we will now dive deeper into the due diligence process.
As discussed in Three Things Buyers Look For, preparing an accurate picture of the business, collecting accounting records, and preparing historical and projected financials are key components in demonstrating a seller’s seriousness. Another equally important task is planning for the due diligence process by collecting and preparing relevant documents that buyers are likely to ask about. Preparing documents ahead of time helps the due diligence process go faster. It can also assist in confirming a buyer’s interest in the business more easily. This helps to save both buyers and sellers from wasting time.
Preparing for the diligence process can also help achieve the best price for the business because a buyer is more likely to feel confident in the business and its prospects if the seller is able to answer questions quickly and provide supporting documents. Responding to information with delays or uncertainty can often be a negative sign to buyers and results in their interest level potentially diminishing at the perceived business risk.
At Firm Exchange, we have integrated a simple and user-friendly way to manage the due diligence process by sharing and reviewing documents within the Diligence Center section of an Exchange Space. Users can attach documents to any message posted in the Diligence Center, which will be shared with all of the members in that Exchange Space. By using different Exchange Spaces to interact with different parties, you have full control over when, and with whom, you share the files.
Preparing Documents for the Sale Process
So where do you start? For those new to the process, we have included the below suggestions for topics that are commonly addressed by buyers. This list is by no means exhaustive, but should serve as a starting point for most businesses.
- Process related documents
- Business overview presentation
- Non-Disclosure Agreement
- Financial Asset Verification
- Letter of Intent
- Purchase Agreement
- Finance and Tax
- Historical financial statements
- Tax returns
- Asset lists with current values
- Liability lists with current values
- Depreciation schedules
- Outstanding debts and liens
- Business plan forecast
- Formation and organization documents
- Proof of ownership
- Stockholder lists
- Insurance documents
- Lease agreements
- Business licenses
- Human Resources
- Employee lists and salaries
- Employment agreements
- Employee manuals
- Training materials
- Sales and Marketing
- Customer lists
- Sample Marketing materials
- Supplier and customer contracts
- Intellectual Property
- Key systems and technology
- Patents, copyrights, trademarks, and other intellectual property
- Licensed software
Sellers should think carefully about what information they share as they prepare their documents. Additionally, they should consider modifying some documents so that they don’t reveal sensitive information, such as social security numbers, business account numbers, logins, etc. Business sales processionals, like business brokers and attorneys, can be helpful resources for anyone looking for guidance.
Preparing for the Due Diligence Process
It is every seller’s dream that a buyer will come along and simply pay the asking price. But, unfortunately, buyers are going to want to ask a lot of questions and find any reason to pay less than the asking price. Additionally, if the buyer is looking to borrow money to help fund the purchase, the lender will likely want to make sure the buyer has an understanding of the business. The lender will also likely want to ensure that the buyer has both a strategic and financial plan for the future. This means that the seller needs to provide responsive, transparent answers to the buyer’s questions.
If a seller doesn’t prepare for questions, the due diligence process has the potential to become long and frustrating for both parties. Therefore, it is important for sellers to gather as much information as they can and anticipate buyers’ questions as much as possible. In addition to the important financial aspects of the business, which we covered in Importance of Cash Flow, buyers are going to want to ask general questions about the business and industry. Sellers should be prepared to answer the following questions:
- Why did the owner decide to sell?
- Is the owner willing to train a new buyer and sign a non-compete?
- What is the current and anticipated competitive landscape and outlook for the business?
- How did the owner determine the asking price?
- Does the business have any outstanding legal or regulatory matters?
- What are the key financial drivers and trends for the business?
- Does the business require additional capital expenditure investments?
- What are the key contracts with customers and employees?
- Does the business have any patents, trademarks, or other intellectual property?
- Does the business own or license any key technology?
The diligence process can often become overwhelming as the number of questions grows. To help stay organized and ensure a smooth diligence process, sellers should set expectations for buyers early on in the process with respect to matters such as:
- How to submit questions to the seller
- Timing of responses
- How to priority rank questions
- What information will be provided at each stage of the process
It is also important to keep a record of questions that buyers have asked, that sellers have responded to, and any others that are pending a response. To help buyers and sellers easily maintain a record of the diligence process, the Firm Exchange platform has an integrated Diligence Center in every Exchange Space that allows buyers to organize questions by topic and submit them to the seller. Both parties are then able to see which questions have seller responses and which are still pending.
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DISCLAIMER: The information contained in this article is for informational and discussion purposes only, and should not be relied upon without seeking your own professional advice. The Firm Exchange, LLC is not a law firm, accounting firm or professional services firm, and accordingly it disclaims any liability for any reliance on the contents of this article. As each situation is unique, you are encouraged to discuss your specific situation with a qualified attorney, accountant and/or other relevant professional services provider.