How to sell your business
Part 2 - Due diligence
Due Diligence
This is the second article in a four-part series outlining the process of selling your business, with a focus on a typical due diligence investigation undertaken by a prospective buyer.
The due diligence process is one of the most time-consuming stages of a transaction, but why is it so important for a seller? This article explores some practical steps a seller can take to save time (and stress!) during the sale process.
Why is Due Diligence Important?
When a buyer acquires a company’s shares, they inherit the business in its entirety – “warts and all”, some might say. From a buyer’s perspective, certain risks can affect how much they pay for the business, or whether they enter into the transaction at all.
Unexpected surprises during the transaction process can delay or even derail the deal. However, the seller can get ahead of the game before it gets to that stage by managing the flow of information efficiently and proactively tackling any risks before they are presented to the buyer.
The respective interests of the parties are underpinned by the need for a thorough and well-run due diligence exercise which paves the way for an efficient deal process.
A buyer typically focusses on key areas of importance to the business. Whilst no two transactions are the same, a buyer will want to know the business is legally compliant, the sellers own what they say they own and that the financials stack up.
Steps to prepare your business for sale
The due diligence exercise can take several months, but diligent sellers can drastically shorten this period with careful planning. Key tactics include:
- Organisation. Consider organising all your business records and files into a centralised electronic file so that information can be collated and circulated easily during the sale process.
- Audit your legal compliance. Consider running an audit of your compliance by reviewing any licences or consents required for the business and ensuring that all key policies such as health and safety, data protection etc. are up to date. A buyer will be attracted to a business taking its legal responsibilities seriously.
- Standardise employment arrangements. Consider ensuring all employees have a legally compliant employment contract. Highlight those individuals that are key to the success of the business and consider appropriate intellectual property protections and restrictive covenants. Resolve any disputes and monitor employee absences.
- Formalise key commercial agreements. Consider reviewing customer and supplier contracts for any risk areas that could bring an end to the relationship (especially if those relationships are fundamental to the company’s success).
- Compile other business information. Consider gathering insurance policies, insurance claims history, software licences, marketing resources and any other documents that help a buyer view the full picture.
- Mock due diligence. Consider carrying out a mock due diligence exercise to identify and tackle weaknesses. Request a sample “legal due diligence questionnaire” from your lawyer to get a flavour of the questions a buyer will ask.
- Engage professional advisors early. Consider speaking to legal, accounting and tax experts early in the process. Professional advice well in advance of a sale can help get your house in order before the buyer starts asking questions!
Efficient information flow promotes trust between the parties and keeps the deal on track.
In addition, the information gathered from the due diligence exercise will inform the buyer’s drafting of the Purchase Agreement. The Purchase Agreement will contain core protections for the buyer such as warranties about the state of the business, which is the focus of the next article in our “how to sell your business” series.
A well-organised due diligence exercise helps the seller identify risks early and take proactive steps to resolve any issues that may present a roadblock. Addressing potential problems upfront not only avoids unpleasant surprises later but also reduces the buyer’s need for extra legal protections such as indemnities, all of which leads to a smoother transaction process and less back and forth between the parties.