Successfully Navigating the Due Diligence Phase

Buying or selling a business can be time-consuming and challenging. While every phase of a transaction has its own set of potential problems, the due diligence period can be especially daunting. In the worst case, disorganization, misunderstandings, and inaccurate information provided during due diligence can send a deal spiraling down the drain. However, with advance planning, and a methodical, organized, and efficient process, the due diligence process can actually be a straight-forward step that moves the buyer and seller to a successful closing.  

The term “due diligence” was first coined in the Securities Act of 1933. So long as stock brokers exercised "due diligence" in their investigation into the company whose stock they were selling, and disclosed to the investor what they found, they would not be held liable for nondisclosure of information that was not discovered in the process of that investigation.

As applied to the process of selling or acquiring a business today, due diligence generally refers to the buyer’s process of verifying company information before closing. Most transactions include a formal due diligence phase, which starts after the buyer and seller have agreed to the broad terms of the agreement, generally by signing a letter of intent. Information reviewed in due diligence can include financial information and bank records, corporate formation and legal documents, employee information, intellectual property, equipment and inventory, real estate and leases, marketing and client records, and much, much more.

The amount of time required to conduct due diligence can vary depending on the size and complexity of the company to be acquired, the seller’s ability to produce and share documentation in a timely manner, and the experience of the buyer and his or her team. In most small and mid-sized business transactions, the due diligence phase will last between two and six weeks.

Whether you’re considering buying or selling a business, here are a few tips for handling due diligence:

Handling due diligence as a seller

We believe that methodical preparation is the best way of ensuring a successful sale and avoiding last-minute surprises that can kill a deal. As a seller, you should start preparing for the due diligence process as soon as you decide to put the company on the market. An intermediary or broker will also help you prepare a due diligence package for prospective buyers. Your ability to quickly provide documentation that supports and verifies information on your business will go a long way in building trust with a buyer, and can help ensure the transaction closes successfully. Conversely, if you’re unable to locate documents, or if you provide conflicting or inaccurate information, seeds of doubt can grow in the buyer’s mind. The buyer may then try to renegotiate the previously agreed price or walk away.    

• Get everything up front. Every company has strengths, challenges, and weaknesses. Even successful, profitable companies have tried sales strategies that didn’t work, introduced new products that bombed, or hired employees who didn’t work out. The best way to handle potential concerns is to disclose everything early in the sales process, so that the buyer finds out information from you up front, not when they’re digging through detailed records just before a potential closing.
• Recognize that due diligence is part of the process. Much as you may dread the thought of the buyer, and his or her lawyers and accountants rifling through your business records, remember that it’s a necessary hurdle which you must overcome to reach the closing table. If you have carefully prepared for a potential sale, have organized books and records, and have clearly and accurately described your business to a potential buyer, due diligence can be simply a time-consuming and administrative process to ensure your buyer feels comfortable enough to move ahead.
• Be tolerant of the buyer. The sophistication and level of expertise of your buyer can have a positive or negative impact on the due diligence process. A corporate buyer who has completed multiple acquisitions in your industry will likely know exactly what they want to verify, and will hopefully get straight to the point. However, a buyer with limited entrepreneurial experience may diligently try to ensure they don’t miss anything, while driving you crazy with requests for obscure information that doesn’t exist in your company or your industry. Working with a buyer to follow a due diligence checklist (described below) can help avoid requests for inappropriate information.

Handling due diligence as a buyer

Before starting the due diligence process, it’s critical to think through the information you need to verify. In addition to ensuring that all business records and the seller’s representations are accurate and honest, your acquisition criteria and goals will also drive your approach to due diligence. For example, if you’re acquiring a company to merge into your existing operations and will shortly be moving inventory to your existing warehouse, you’ll want to verify the lease can be cancelled, while you probably don’t care about future warehouse rent increases.       

• Prepare and prioritize a due diligence checklist. Before starting any due diligence, prepare a list of everything you want to see, then share the list with the seller and agree on a timeline. Ask the seller if they anticipate any problems providing the information you’re requesting. Update the list as you receive, see, or verify requested information. A list also helps save time and effort to prioritize. If you know that certain items could be deal breakers, request that information first.
• Use your team and technology. Be sure to work in conjunction with your lawyer and accountant, who will likely provide suggestions to add to the list, and help ensure that all documentation required in advance of closing is included. Depending on the amount of information requested and the size of the team reviewing documents, it may be helpful to use an electronic data room, where documents are stored on a password-protected website.
• Put yourself in the seller’s shoes. Hopefully your seller is organized, prepared, willing to provide you with all the information you want, and has every business detail at their fingertips. But bear in mind that the owner is still running the business on a day-to-day basis, and may be concerned about maintaining confidentiality associated with the sale. If the employees don’t know about a pending sale, a seller may not be able to delegate your requests for information to his or her employees. Delays can also occur when information needs to be gathered from the seller’s bankers, accountants, lawyers or other advisors.

While due diligence can be time-consuming and frustrating, an organized, methodical process can help both the buyer and seller, leading to a successful closing. To receive our latest due diligence checklist, email us at info@hughesklaiber.com.

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