Expert advice on how to prepare for due diligence

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Once you have an offer (Letter of Intent) for the purchase of your company, the next step will be the beginning of the Due Diligence process. It is mainly conducted in three areas: financial, legal and operational due diligence.

Due diligence is not just important for the buyer to check if the company he is going to acquires has no surprises; it's also crucial for the seller. The seller needs to prepare for the due diligence process to ensure that the transaction proceeds smoothly and the buyer is satisfied with the information provided. When a seller doesn’t prepare for due diligence, it can turn into an expensive and time-consuming undertaking.

Why prepare for the Due Diligence?

The main objective of "due diligence preparation" is to address potential problems before putting your company on the market. To attract a sophisticated buyer to your company, you should prepare for the due diligence process well before you start the sale process. This is especially true for middle-market companies, as conducting pre-sale due diligence can be the difference between receiving a good price and missing out on a deal altogether.

The benefits for preparing Due Diligence are:

1. Solve problems before they become problems

When a buyer decides to buy your company, you will conduct your own due diligence to determine what is really going on with your company before committing to buy it. Unexpected problems that arise in the course of the buyer's investigation may scupper the deal.

A seller can resolve many of the issues before a buyer ever learns of them with advanced warning of any unsettled problems. Further, a problem identified in advance that can be explained will keep the seller’s credibility intact.

Preparing for due diligence allows the seller to resolve issues before the buyer enters the picture. There is nothing worse than spending time and money preparing and marketing your business for sale and finding a qualified buyer, only to lose the buyer because of an unforeseen problem with your business that could have been resolved beforehand. This situation happens more often than sellers realise because, despite working on their business full time, owners are often unaware of seemingly simple problems.

But, those simple issues can have a material effect on a buyer’s perception of the relative risk of a company if they are not resolved in advance. For example, issues with financial records, if not addressed beforehand, usually trigger demands for a lower price, more restrictive deal terms, or may cause the buyer to walk away from the sale entirely.

2. Greatly improves the likelihood of a successful transaction

It allows your advisory team to correct potential problems and help avoid pitfalls in the sale before exposing the business to buyers. With inaccurate financial records, you run the risk of losing a buyer because, by the time the buyer discovers the flaws during the sale, you may have lost a buyer. due diligenceThe sale has to be delayed in order to fix the problems. After spending many months looking for a buyer, to lose the buyer over something that could have been corrected from the start is a great disappointment and a waste of valuable time, money and resources.

Retain a third party to examine your financials — profit & loss statements, balance sheets, and federal income tax returns, and to scrutinize key ratios, trends, and other data, and provide you with a report of their findings. This helps spot potential issues that a buyer may find with your financial records and allows you to address these issues before you ever receive an offer.

3. Speed up the due diligence process

When you have all your finances in order before sell your business it also potentially speeds up the due diligence process once you have a buyer, resulting in a higher likelihood of closing the deal. People like to do things very well but also fast and that helps the whole process.

This is because a buyer who has issues with your financial records will most certainly conduct due diligence very thoroughly, looking for problems in other areas as well.

4. Maximise the selling price

The main reason is that identifying issues in a pre-sale due diligence helps to avoid complications that can affect the ongoing transaction. Accurate financial records may also maximize the sale price of your business by attracting buyers who are confident in your business. Simply put, the more organized your business’s financial records appear, the quicker you are likely to sell your business and receive top dollar.

A thoughtful evaluation of the business before the sale process begins will make the undertaking more manageable, efficient, and cost-effective for a seller.

The following could be the steps a seller can take to prepare for due diligence:

  1. Organize the information: The seller should organize all the information that will be requested during due diligence. This includes financial information, legal documents, contracts, and other relevant information. The information should be easily accessible, and the seller should be able to provide it quickly to the buyer's due diligence team.
  2. Conduct a self-audit: Before the buyer conducts their due diligence investigation, the seller should conduct a self-audit to identify any potential issues or red flags. The self-audit should cover all aspects of the business, including financial, legal, operational, and commercial. The seller should identify any areas that need improvement or corrective action.
  3. Address any identified issues: If the seller identifies any issues during the self-audit, they should take corrective action to address them before the buyer's due diligence team begins their investigation. By proactively addressing any issues, the seller can demonstrate that they are committed to transparency and honesty.
  4. Be transparent and responsive During the due diligence process, the seller should be transparent and responsive to the buyer's requests for information. They should provide the information quickly and accurately, and they should be available to answer any questions that arise.
  5. Manage expextations: Finally, the seller should manage the buyer's expectations during the due diligence process. They should be realistic about what information they can provide and should be clear about any limitations or constraints. By managing expectations, the seller can help ensure that the due diligence process proceeds smoothly and that the transaction closes successfully.

A team of experienced advisors will help you to prepare your company for sale very well for due diligence and to address all important issues before starting the sale process. From Baker Tilly we strongly recommend that you invest time preparing your business for due diligence. Most business owners skip this step altogether. By preparing for this process, you will greatly improve the chances of a successful sale. Additionally, demonstrating to the buyer that you have prepared for due diligence increases the buyer’s confidence in your business and reduces their perception of fear.

Due diligence can be heaven or hell. If you have your finances in order and everything is going well from an operational and legal point of view, the chances are that due diligence will go smoothly and your business will take off and bring you one step closer to the closing of your dreams. If you are not prepared and the buyer detects any problems during due diligence, you will be faced with a dilemma. Preparing for due diligence can make it much easier to get the outcome you want.