Due Diligence When Selling a Business

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Due Diligence: For the Seller

Anyone who has been reading this blog for a while has some idea what due diligence is.

In our context, it’s generally considered to be efforts made by the buyer of a business to thoroughly research the target business to; 1)  confirm what the seller or broker has been telling them about the business; 2), determine if there are any undisclosed problems or liabilities, and; 3), determine if the business has the potential to provide the return required by the buyer.

But any reasonably intelligent business owner that is considering selling – and any equally intelligent business broker advising on a potential sale – would anticipate what a buyer’s due diligence will involve and do as much as possible for that buyer before he or she even shows up on the radar. The objective here is to make it as easy as possible for the buyer to buy.

Here are some ways to do this.

The Materials

Gather and organize all the materials a buyer will likely need to evaluate the business. At minimum, this will include:

  • Tax returns for the most recent three to five years. We suggest five.
  • Financial statements, preferably audited or prepared by a CPA, for the same time period.
  • Current financials; i.e. year-to-date
  • Copies of all leases for any real estate and equipment
  • Client contracts; those for which the business has to perform
  • Vendor contracts; those that will be performed for the business.
  • Documentation for any loans/notes that the business is liable for.
  • Current pay-ables and receivables.
  • Most recent inventory numbers.
  • Bank statements for at least the most recent 12 months.

There will be other data that many buyers will need and the specifics will be determined by the type of business being sold and the sophistication of the buyer. Think through what a serious buyer would want to see. A professional business broker will be very helpful in this regard.

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Our course, The Basic “How-To” of Becoming a Business Broker”, teaches how to become a professional business broker.

Become a Professional Business Broker…

Legal Profile

This could arguably have been placed under Materials but most sellers – and quite a few business brokers – neglect this until it comes up at closing. A well organized legal profile will make for a smooth, successful transaction.

What I mean by this is that all legal documentation should be in one folder. Some examples:

  • Organizational documents
  • Shareholder agreements
  • LLC membership allotments
  • Operating agreements
  • Authorization to sell
  • Certificates of good standing
  • Any special licenses, as well as the business license
  • Rights to intellectual property; i.e., trademarks, patents, etc.
  • Third-party financing agreements
  • Letters of credit.

Cleaning Up

“Cleaning up” pertains to two aspects of this process.

1.) Yes, cleaning up the joint is one. If the space that the business occupies and generates revenue from is a mess, a buyer will wonder about all other aspects of the business – such as its operations – and be put off. This will immediately reduce the business’ value in the mind of any buyer.

2.) Cleaning up the books – the financial information, checking account balancing, making sure all tax returns are filed, etc. – is a critical step in the preparation for bringing a business to market. We’ve seen many deals fail apart because the financials were a mess and the seller could not adequately explain the confusion.

We find incomplete or inaccurate financials so often that we’ve actually begun to offer a service to sellers to clean up their books. One of our earliest licensees was a CPA and the CFO of a publicly-traded U.S. company. He started doing some financial clean up for the businesses listed with his office and then started doing it for other offices in our network, as well. This can be a handsome revenue generator for business brokers, especially those with a financial background.

Assets

List and review all assets. Identify those that are owned by the business and those that are not but are used by the business.

Is the real estate owned by the business? Should it be? I’ve written here and here about how real estate should be held to provide the most beneficial options to the owners when it’s time to sell. If the ownership has to be adjusted, the time to do so is before the business comes to market.

There may also be other assets that are problematic. For instance, the owner may want to keep a vehicle used by the business. Not only does that have to be removed from the list of assets that will be transferred but the buyer’s cost to replace it will have to factored into the financial equation.

We had a transaction that involved the sale of a specialty metal fabricator that operated in four U.S. states. This company did work for various government departments and large publicly-traded businesses. Some of its projects required a large crane.

The seller wanted to keep the crane and operate a crane business post closing – offering his crane services to the buyer, among others. We had to adjust the asset list and the financials to reflect the reduction of the crane revenue to project a truer picture of what the business would look like after closing without that crane.

Always make sure that the assets that are to be included in the transfer are owned by the right entity.

Prepare for the Due Diligence Process

As I mentioned in last week’s post, a major aspect of the sale and purchase of a business is the buyer’s due diligence. A buyer is going to want to dig deeply into all aspects of the business to make sure he or she is getting what they think they’re getting. This process can seem intrusive but the seller should ask themselves what they would want to see if they were buying the business.

If not prepared for, due diligence can be time consuming, particularly if the data has to be gathered when the potential buyer asks for it. Therefore, before you start the selling process, meet with a professional business broker to ensure that all the information a buyer would need is organized and readily available.

We’ve put together a short list of items that we offer to business buyers to help them prepare for the most basic due diligence process that they should go through. If you’d like a copy, let me know where to send it here and it’ll be on its way.

The Bottom Line

Doing as much of a buyer’s due diligence before bringing the business to market will be beneficial in three ways.

1.) It will make the buyer’s life easier and his or her due diligence proceed more quickly, getting the deal to the closing table sooner.

2.) It will give the seller time to clean up any problems before the buyer appears.

3.) Everything else being equal, it will re-enforce the value placed on the business and reduce the amount of haggling over price.

Being ready will maximize the value of the business and help avoid a price renegotiation. Don’t neglect this.

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Our course, The Basic “How-To” of Becoming a Business Broker”, teaches how to become a professional business broker.

Become a Professional Business Broker…

If you have any questions, comments or feedback on this topic – or any topic related to business – I want to hear from you. Put them in the Comments box below. Start the conversation and I’ll get back to you with answers or my own comments. If I get enough on one topic, I’ll address them in a future post or podcast.

I’ll be back with you again next Monday. In the meantime, I hope you have a profitable week!

Joe

#business #businessacquisition #sellabusiness #becomeabusinessbroker #businessbrokering #businessvaluation #MergersandAcquisitions

The author is the founder of Worldwide Business Brokers and holds a certification from the International Business Brokers Association (IBBA) as a Certified Business Intermediary (CBI) of which there are fewer than 600 in the world. He can be reached at joe@WorldwideBusinessBlog.com

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