If you’re preparing to sell your business, you may have heard the term due diligence. But unless you’ve been through an M&A deal before, you might not know what the due diligence process entails.
What is the due diligence process?
Due diligence is a process a prospective buyer follows to confirm that what the seller says about the business is accurate and uncover any issues that might negatively impact business value or tank the deal altogether.
Many sellers believe if they’ve gone through a financial statement audit in the past, then due diligence should feel pretty familiar. However, the due diligence process is so much more.
What elements does a buyer consider when they perform due diligence?
The due diligence process often starts with an examination of the business’s financial records. If you have an annual financial audit, this part of the process should be much faster and easier.
Other areas a buyer may dig into include:
- Buyers will want to review contracts for all major business relationships, including real estate and equipment leases, supplier and customer agreements, and employment contracts.
- Tax compliance. Buyers want to examine the different types of taxes that may be imposed on the business and the various tax jurisdictions in which the company might have physical or economic nexus. This includes income taxes, sales, and use taxes, payroll and employment taxes, property taxes, excise taxes, etc.
- Buyers want to determine whether the company’s major customers will continue doing business with the company after the sale. This can be tricky if you don’t want to alert customers to the fact that you’re selling the company.
- Information technology. Buyers will look at the company’s IT infrastructure and processes to evaluate the security and financial risks. This assessment might cover technical debt, software licensing, and how sensitive data is managed and protected.
- Buyers may read employee reviews on sites like Glassdoor to understand how employees view the company. They may also want to survey employees on company culture. Again, this step can be tricky if you aren’t ready to discuss a potential sale with employees.
- The buyer will review the company’s insurance policies dating as far back as possible to determine whether the company’s existing insurance covers its risks, what deductibles or retentions apply, any applicable exclusions, and whether the policies address assignments. They may also look at claims history and pending or potential claims that might erode policy limits.
- Market reputation. The buyer may evaluate the target company’s standing in the market by looking at social media sites and reviews on Google or Yelp.
This is far from a comprehensive list of what a buyer might look at during its diligence investigation, but it’s a good starting point for preparing for a sale.
How long does the due diligence process take?
According to the United States Chamber of Commerce, a reasonable investigation into a business generally takes 60 days, but in our experience, the process can take much longer—especially if you’re not prepared.
That’s why it’s crucial to bring your CPA in early on. Your accountant knows your business and what an acquiring company will be interested in. They can help you do your homework before entering the process, so you’re prepared when the request list comes in.
Often, buyers are represented by a firm that doesn’t tailor its diligence checklist and sends a 25-page document asking for information that doesn’t apply to the target business. This can be overwhelming for sellers, and your CPA can also help determine what is and isn’t applicable and how to respond.
For most business owners, selling a company isn’t an everyday event, and it can have a dramatic effect on day-to-day operations. Remember that you need to continue running the business during the diligence investigation, which can be challenging if you’re not prepared for the work involved.
Dropping the ball at any time during the due diligence process can cause profits to suffer and the deal to fall through. To maximize your chances of selling your business for the best possible price, it’s a good idea to proactively look at your company the way a buyer would. Contact your Walter Shuffain advisor for help.