When discussing the purchase or sale of a business, one of the first topics to address is the due diligence process. What does that mean for the Seller? What should the buyer be looking for? The answer is contained in a long and thorough checklist.
As a Seller, it means you must be prepared to present paperwork or reports that answer due diligence inquiries, and that any area where you are not prepared can potentially delay the sale or, worse, derail it altogether.
As a buyer, this means that you want to thoroughly investigate a business before making a purchase, ensuring there are no hidden costs or surprises that could cost you in either the short or long term. The process can be lengthy, and if the Seller is unprepared in certain areas, that may be a red flag for you.
What is due diligence made up of, exactly? Here are some key elements of due diligence, along with what you need to know about each.
Organization and Good Standing
The organization of a company, from an LLC to an S-Corp, and its current standing, determine whether it can sell and how easily that process can be completed. There are several steps to preparing this information, and it is best to have a professional assist you, as a Seller, in getting it ready.
As a buyer, this is the foundation of other things you will ask for. If an organization is not in good standing or the business type does not align with the business, that could mean a significant amount of work on your part.
This first step is one of the most important in the due diligence process and is vital for both sides to get right.
Financial Information
As business brokers, we often discuss recasting your books. This item of due diligence is why. The reason is that most small business owners have their books set up to maximize tax benefits, rather than accurately reflecting the business’s true income potential.
The buyer wants to know what the business truly makes and its growth potential. These are both significant selling points and play a substantial role in the business valuation process. If you, as a buyer, are going to purchase a business, you need to know that it is worth what you are paying for it.
You also want to know about those taxes and what the business’s tax liability has been. That will also help you determine if this is the right business for you to purchase.
Physical Assets
This part of due diligence discusses the assets the business owns. This includes property and equipment, as well as any recent upgrades and the leases that the buyer can expect to continue.
As a buyer, this is a surprisingly common deal-breaker. If the current landlord does not wish to continue the lease with you or wants to negotiate for higher rates, this can affect the viability of the business you are purchasing.
This process is often separate from the business valuation process and is vitally important in the due diligence phase.
Real Estate
You’ve heard the phrase ‘location, location, location’? What locations does the business have? Are they owned or leased?
As a buyer, you need to understand if business locations are secure for at least the near future. Moving a business after you take over adds both responsibility and risk. Be sure you know and understand both.
Intellectual Property
As a Seller, are there patents that go with your business? Is your business name trademarked, and do you own any copyrighted items? Do you have proprietary knowledge and expertise? How do you protect those things?
As a buyer, you must understand that it is often intellectual property that sets you apart from your competition, not physical property. If some of it is not included in the business sale, that could spell trouble. This is often why it is a good idea to ensure that the outgoing owner will not be starting a new business that competes with yours.
Employees and Employee Benefits
This is an area that can be challenging when buying a business. The reason? Sometimes, the business owner does not want to inform employees or even family members when they are selling a business, fearing that they will leave and disrupt the business.
But a buyer does need to know some things, especially about key employees. You must negotiate and determine what that looks like early on. If many employees leave as a result of the business sale, the resulting issues can be difficult or impossible to recover from.
Licenses and Permits
This is especially important for contractor and service-type businesses, or when selling a medical practice. Not all licenses and permits are transferable. In fact, in California, there are not many. The buyer must obtain their licensing and, in some cases, new permits.
As a buyer, you will need to determine those licenses and what they will cost you on your own. That helps you determine the actual cost of the business to you.
Environmental Issues
There are two common types of environmental issues. The first is to conduct environmental studies of your property or the property you rent or lease to ensure there are no issues that could lead to fines or, at worst, shutdown.
The second aspect is the materials you use to conduct your business and their impact on the environment. Suppose you have a landscaping, pest control business, or other business that handles chemicals and other potential pollutants. In that case, this includes everything related to those materials, including how you dispose of them, as well as MSDS sheets and other documentation on all of them.
Material Contracts
Whatever contracts the company has, especially those that will remain binding even after the company is sold, should also be shared. This includes employees, contractors, suppliers, customers (more on this later), and others.
The buyer will also want to see your past contracts, at least for the last few years. They want to ensure that those contracts have been fulfilled, but it also provides them with insight into how the business is being run.
Customer Information
As a business owner, you may be reluctant to release your current and even past customer and client lists.
However, they are essential to the buyer, so they know that first, they can continue doing business with your current customers. Secondly, they also show customer history and lifetime customer value.
When buying any business, it is essential to know that you will have ongoing customers. However, it is also crucial to the Seller that you do not share those client lists with anyone. At this point, you are likely subject to a non-disclosure agreement, and this information must be kept confidential and secure.
This is often done digitally, in virtual data rooms hosted in the cloud, which can only be accessed by individuals with the proper credentials.
Products and Services
This only makes sense, but it bears repeating here because you need to show not only what you offer now, but also products or services under development —things that could be coming in the future.
Additionally, the buyer wants to know about any problems you have had in the past. The products and services that a Seller provides and that a buyer will continue to provide are the heart of the business and are what keep customers loyal.
Litigation
The buyer wants to know if the business is being sued, has been sued, or is likely to be sued soon.
As a buyer, this means you need to do a little digging. If anything at all feels off in this area, consult your attorney. Have them thoroughly inspect the business.
This is another shared space where a sale can go awry. Honesty and transparency from the beginning on both sides are critical.
If you sell your business, one of the items you will need to know and be comfortable with is a Covenant Not To Compete.
Insurance and Professional Contacts
As a Seller, it is essential to show that you are insured, and who provides your coverage. This makes it easy for the buyer to see those costs. It also makes it easy for them to see that you are insured and what coverage they will need.
As a buyer, you’ll also want to know who the Seller uses for things like accounting, an attorney or attorneys, and others. You can either continue the relationships with those who already understand the business or bring in your own choices, but at least you know what you need and approximately how much it will cost.
Articles and Publicity
What kind of press and attention is the company for sale getting? Are there articles, television appearances, ads, radio spots, or other public appearances scheduled? Is the new owner expected to continue doing all of those things?
As a buyer, this helps you to see what kind of marketing work the company is already doing, and can give you ideas about what to do next and what has not worked in the past.
Does all of this sound very time-consuming and, in some cases, costly? It can be. This due diligence process is one of the reasons it takes a considerable amount of time to sell a business. It is also the reason that you should not try to sell a business on your own.
If you focus on all of these tasks, you will likely not have enough time to run your business as it should be. You should enlist the help of a business broker, who will not only help you with a business valuation but will also assist you in coordinating this process. It will involve your attorney, accountant, and other professionals you will engage to help you prepare your business for sale and complete this process.
Do you have questions about selling your business? This link offers 5 tips to follow when selling a business.
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Want to understand due diligence better? Contact us at Rogerson Business Services. We’d love to discuss how we can help connect you with the right buyer at the right time to sell your business faster.