Before making an offer for your business, most buyers will ask for a period of due diligence. This block of time allows them to take a deep dive into your business and make an informed decision about the purchase. Here, we’ll help you learn the ins and out of the due diligence process and the role you, as the seller, will need to play.
What is due diligence?
In the context of buying a business, due diligence is the work a prospective buyer engages in to study its strength and drawbacks.
Most use this time to assess the business’s financial strength, verify a seller's claims, and ensure that they have a solid understanding of the business as it stands today.
How will the buyer assess my business?
The buyer will want to read any document they can obtain that helps them learn what you do, how you do it, and the kinds of profits you earn from the process. Let's dive into a few parts of your business they'll want to learn about:
Financial aspects
Buyers will want to have a good sense of your business's financial standing. Here are a few steps they might take:
- Ensure that your tax returns and financials have passed a formal audit.
- Assess and project its profitability.
- Study your business’s debts and liabilities and the risks of taking them on.
- Look into the speed of inventory turnover.
- Conduct valuations on the inventory, furniture, fixtures, equipment, and building(s) offered in the sale.
- Find out if you used your business accounts to cover personal needs.
Note: Most will adjust those expenses out of the numbers to create a realistic account of your business’s cash flows and profitability. - Study sales patterns.
- Review employee benefit claims, settlements, liens, and uses of assets as collateral.
- Sum up the age of the accounts receivable.
- Study the payment patterns of your top accounts.
- Assess how quickly your business has paid its bills and whether there are any liens on the outstanding payables.
- Compare your employees' wages to industry standards.
Legal aspects
To study the legal status of your business, buyers may take on these tasks:
- Ensure your business is legally registered in its state of operation.
- Study key documents, contracts, and agreements that bind the business and confirm that your business complies with them.
- Ensure that the intellectual property up for sale has been appropriately filed.
- Read over the terms of real estate leases and find out if they can be transferred to a new owner.
- Study past legal issues, including claims of wrongful terminations, settlements, disputes over intellectual property, or outside investigations, and how they were resolved.
- Ensure that your business complies with local zoning and environmental laws.
- Review your business’s liabilities and if there are any legal ramifications to them.
Other aspects of the business
Of course, there are other tasks buyers may want to take on. Here are a few:
- Read your business’s policies and procedures.
- Confirm that your business meets safety and health requirements.
- Review your business’s insurance coverages.
- Assess your business’s standing through the Better Business Bureau, licensing agencies, industry associations, credit bureaus, and the local police station.
- Study the practices you use to win market share.
- Look into your customer base, customer attrition rates, and common buying patterns.
- Find out if any customers have a personal connection to you and, if so, whether they'll keep working with the business after it changes hands.
- Study your business’s competitive position.
- Review pricing lists and compare them to competitors’.
- Study how customers responded to past price increases.
- Look into what influences your business’ industry and pool of buyers.
- Read customer reviews of the business.
- Obtain a list of employees, contract workers, and union agreements and review the contracts and policies that pertain to them.
- Read Glassdoor, blogs, and other review sites to learn about your employees’ experiences with your business.
What will the buyer ask to see?
The buyer will likely ask to see your financials, founding documents, procedures, and HR records to form a complete assessment of the business.
Some of the materials they might request include:
- Founding paperwork, including the business’s articles of organization or articles of incorporation
- Valid permits and business licenses
- Proof of trademarks, copyrights, and patents
- Insurance declarations
- Real estate documents or lease information that spells out terms and transferability
- Contracts, including lease and purchase agreements, distribution agreements, vendor contracts, subcontractor agreements, sales contracts, union contracts, employment agreements, and other contracts the business is bound to fulfill
- Three to five years’ worth of financial records, which should include tax returns, balance sheets, profit-and-loss statements, sales records, debt disclosures, payroll information, and marketing costs, as well as a 30-, 60-, 90-, and >90-day breakdown of accounts receivable and accounts payable information
- Organizational charts
- HR policies and benefit plans
- Inventory records and valuations
- Furniture, fixtures, and equipment records and valuations
- Information regarding closed and outstanding legal concerns
- A certificate of good standing, which you can attain from the Secretary of State in the business’s home state
You can find the questions we tell buyers to ask in this guide:
Can I take steps to protect this information?
Yes. Ask anyone who will access your records to sign a confidentiality agreement. This agreement will ensure that buyers don’t disclose anything they learn to an outside party. At least, not without your consent.
You can download a template for this agreement from a legal services site. We prefer this one from Law Depot. Or, you can work with your attorney to create one that meets your needs.
Would you like to connect with an attorney who can help you with this step? Click the Connect button below to get started.
How long will the process take?
In most cases, buyers can complete this process within a few weeks. But it can take months to study large, complex businesses.
Your buyer should tell you how long they’ll need to pour through your business documents. This timeframe begins after they receive all the documents they request. If they don't provide a timeframe, you can set your own to keep the sales process moving.
What’s next?
After the seller portion of the due diligence process is complete, you may receive an offer for your business. We have two guides to help you with this step:
Then, log into your owner’s portal for a free step-by-step guide to selling your business.
