Preparing for due diligence: Ensuring you and your business are ready for sale

When selling a business, due diligence (DD) is one of the most critical yet often overlooked aspects of the process. DD refers to the detailed investigation and analysis conducted by potential buyers to validate the accuracy of representations made about a target business prior to finalising an acquisition. Thorough DD analysis encompasses scrutiny of financial statements, customer contracts, operations, tax filings, legal compliance, technology systems, and more.

Failing to adequately prepare for DD can derail a deal at the last minute. Conversely, business owners who proactively ready themselves and their companies for DD can maximise purchase price, accelerate deal completion, and reduce negotiation leverage held by prospective buyers. This essay will summarise key considerations around preparing for and navigating DD to achieve an optimal outcome when selling your company.

Why DD Matters

DD serves the essential purpose of affirming the credibility of the target business for acquirers. Buyers want assurance that revenue streams are predictable, liabilities are limited, and representations around historical performance are valid. Any material issues uncovered during DD may require renegotiation of the deal to account for newly identified risks. In extreme cases, buyers may walk away entirely if previously unknown problems come to light.

Sellers should thus approach the DD process as an opportunity to demonstrate confidence in their business rather than treating it as an annoyance. Embracing transparency and adopting diligent record keeping practices well in advance of commencing a sale sets the stage for smooth DD proceedings.

Who Conducts DD and What They Analyse

DD may be performed directly by a prospective buyer and their advisors or outsourced to a third party. Areas scrutinised range from corporate entity structures to employee matters:

• Financial – Historic and projected revenue by product/service, customer concentration, profit margins, working capital efficiency, capex requirements and more
• Tax – Past returns and audits, transfer pricing, nexus analysis, deferred taxes, incentives, liabilities
• Legal – Compliance status, disputes and litigation, contracts, intellectual property protections
• Commercial – Supply agreements, lease terms, licensing constraints, insurance coverage
• Technology – Infrastructure inventory, data security, backup processes, roadmaps
• HR – Organisation chart, compensation, turnover risks, culture assessment

Undertaking DD internally strains buyer resources. Large corporations thus tend to outsource DD to firms who specialise in these investigations. Expert third party assessors often unearth issues overlooked by buyers focused narrowly within their industry. Sellers should thus prepare for intense inspection from seasoned DD professionals.

Getting Your House in Order  

Business owners can take numerous steps to ready their company for the scrutiny of DD:

1. Maintain meticulous financial records – Compile historical monthly and annual income statements, balance sheets, and cash flow statements covering the past 3-5 years. Reconcile all accounts and keep an audit trail of adjustments made. Clearly track revenue, cost of goods sold, and gross margin data cuts by product lines, customer accounts, and geographic regions.
2. Formalise recurring procedures – Document month-end closing, account reconciliation, revenue recognition, inventory counts and other routine accounting processes. Ensure consistency quarter-to-quarter and avoid big adjustments that raise questions over the quality of normal reporting.
3. Clean up the corporate entity structure – Eliminate outdated entities, consolidate affiliated subsidiaries, and clarify cross-ownership stakes before putting a business on the market. Messy organisation structures increase risk of undiscovered liabilities residing in a forgotten entity.
4. Sort out related party arrangements – Scrutinise employee compensation, shareholder distributions, related party loans, joint ventures involving internal stakeholders, and other potential conflicts of interest. Eliminate or formally document legitimate related party dealings.
5. Inventory assets – Catalogue tangible assets like production equipment and technology systems as well as intangible assets including trademarks, patents, licenses, and data. Maintenance logs, ownership documentation, and value substantiation offer useful artifacts.
6. Gather customer and vendor artifacts – Supply agreements, statements of work, service contracts, licensing paperwork, and documented revenue commitments provide tangible proof points on the stability of key commercial relationships.
7. Conform to regulations – Confirm compliance across all governing bodies associated with your industry to avoid fines, business interruptions, and costly remediation.
8. Retain trusted advisors – Engage financial, legal, tax and technology consultants with subject matter expertise to audit your company, identify gaps, recommend remedies, and serve as guides through the DD gauntlet.

Navigating Queries

Once DD commences, buyers and their advisors will probe into question areas through information requests, site visits and management interviews. Responding to these inquiries in a poised, cooperative manner is vital. Some best practices include:

• Assign dedicated internal point persons to coordinate information gathering for the DD team and convey responses in a timely fashion. Failure to provide requested data promptly raises perceived risk.
• Field detailed questions directly and avoid speculation or overly generic answers. Volunteer adverse information that the DD team would eventually uncover themselves.
• Maintain consistent messaging across the management team throughout DD information exchanges and interviews. Conflicting narratives undermine credibility.
• Frame challenges uncovered as opportunities for improvement rather than simply deficiencies. Offer potential solutions along with identifying issues.

Staying Calm Under Pressure

DD places enormous demands on the target business right when staff need to remain dedicated to sustaining operations. The layered nature of financial, operational, legal, tax, and technology oriented analyses strains bandwidth. The temptation emerges to want to change habitual practices to fix self-identified shortcomings, fill gaps, cut corners or impress suitors. Avoid these instincts.

Attempting to overhaul systems or processes during DD telegraphs risk to buyers. The safest posture involves conducting business as usual while proving full transparency into normal operations. Expect intense scrutiny but take comfort that surviving a tough DD signals underlying durability that buyers value. With meticulous preparation and steadfast poise during DD, sellers gain leverage to negotiate winning deals selling their business.

For more information contact Ballards at 01905 794 504

Disclaimer. This article has been prepared for information purposes only. Formal professional advice is strongly recommended before making decisions on the topics discussed in this release. No responsibility for any loss to any person acting, or not acting, as a result of this release can be accepted by us, or any person affiliated with us.

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