Due Diligence: What To Expect As A Seller

For most, the sale of a business is a new experience that requires sellers to learn many entirely foreign processes in a very short amount of time. The many steps to selling your business can be long and tedious, and chief amongst those steps in terms of length and tedium is due diligence. 

To those unfamiliar, due diligence is the process by which buyers attempt to gain a full, or at least as clear as possible, picture of the business they are considering purchasing. Buyers do this by preparing a due diligence request list which is essentially a list of every question a buyer and their advisors may think relevant to analyzing the condition of the business being sold. This request list will touch on most every aspect of the business and will require sellers to explore areas of their business that they may not have considered in decades or may never have considered. That being the case, the due diligence process can be extremely daunting to sellers who are not adequately prepared, so it is important to consult with your legal counsel and M&A advisory firm to begin compiling information early and to hopefully reduce the time, cost, and pain involved.

To help prepare for the due diligence process, below is a list of what tend to be the most important and lengthy areas of due diligence:

General Corporate Records. Generally, as the starting point of a buyer’s analysis, they will want to confirm that the entity exists and is in good-standing and that the parties attempting to sell the business have documentation of authority to do so and of their ownership of the business. From the company’s formation and governance documents, minute-books, stock ledger or other records relating to stock or membership interest grants, Buyer will want to see any and all records of the company in order to get a better idea of its history. Additionally, Buyer will expect to see confirmation of the company’s present status in any jurisdiction in which the business transacts business to confirm that the entity is in good standing. To the extent that your company has not perfectly maintained its records in an organized and consistent manner (most sellers will be in this position), preparation for this area of due diligence will be key to reducing the pains associated with due diligence and your legal counsel will be able to help you identify and correct potential issues before they arise in diligence.

Financial Statements and Records. This is the area of due diligence that buyers tend to care most about as they are attempting to confirm the valuation of the business and therefore the soundness of their investment. Unfortunately, from a legal perspective, there is only so much that can be said other than consult with your accountant. We strongly recommend that sellers begin working with your accountant before they make it to the due diligence process to ensure that your financial records and tax returns are accurate, up to date, and consistent, or to work to prepare an explanation for any inconsistencies. 

Material Contracts. To gain insights into the operation of the business broadly, and, more specifically, the source and security of the company’s revenue streams, its employee, supply and customer relationships, and its debts and obligations, Buyer will expect to see most of the agreements to which the company is a signatory. This will likely be the most time intensive area of due diligence as determining what must be provided, tracking down the executed copies of the identified agreements and accurately describing them in a digestible and acceptable-to-Buyer format tends to require multiple rounds of overbroad requests from Buyer and incomplete answers from Seller. That being the case, it is extremely worthwhile in terms of time and legal expenses for sellers to think through the universe of relationships and agreements necessary or important to the operation of the Business and to work to compile these documents before the due diligence process gets underway. 

As part of this portion of due diligence, Buyer will want to know what may be affected as a result of the sale of the business or the assets of the business. This will entail a review of material contracts looking for any provisions restricting change-of-control (for a stock or membership interest sale) or assignment (for an asset sale) to ensure that the company is not losing its biggest customer or supplier as a result of the transaction. Again, this can be lengthy process to review dozens, hundreds or even thousands of agreements, so the sooner your counsel has access to these documents and can begin reviewing, the sooner these potential issues can be identified and corrected, if possible, and the sooner due diligence can be completed.

Consents. Depending on the nature of your business and whether you rent or own the real property on which the business operates, there will likely be third-parties from whom consent or approval is required in order to close the sale of your business. The Material Contracts portion of due diligence described above may identify certain suppliers, customers, licensors and/or franchisors, key employees, or other third-parties who must consent to the transaction and the eventual assignment of the business’s relationship with these third-parties to the Buyer. This is one area that is likely to cause delays later in the transaction as getting in touch with these third parties and negotiating their consent or approval takes time. That being the case, it is crucial to identify these individuals early, so that you and your counsel can take the necessary steps to effectively and timely obtain all necessary consents.

Disputes and Litigation. If your business is being sued, potential buyers will want to know the details and what this may ultimately cost the business. This will likely include both ongoing litigation and any potential or threatened litigation that the owners of the business are aware of or should reasonably foresee. To the extent there are any claims or potential claims against the company, you will want to consult with your legal counsel to determine what needs to be disclosed and to discuss how to resolve the issue or to ultimately approach disclosure to minimize any resulting fallout.

These are just the areas of due diligence that tend to be the most important and time consuming in the average deal, but due diligence can and often will touch on many other areas of your business, so we strongly recommend working with your legal to counsel to determine what areas you need to consider and prioritize, to identify what your company’s specific pain points may be in this process and to develop a game plan to address them. Due diligence can be a grueling and expensive part of any transaction, but so long as you know what to expect going in and have worked to prepare yourself, you can and will overcome it.

If you are considering the sale of your business and need legal assistance in navigating this process, please contact Ritchie Taylor at Manning Fulton or visit our website to review our Mergers and Acquisitions practice services.