In our last blog in the Buying and Selling Business series, we discussed action steps needed to properly prepare for the purchase or sale of a business. In this blog we’ll move into due diligence and how it pertains to the process of buying and selling a business.
What even is “Due Diligence”?
“Due Diligence” is the phase of a business sale where the buyer and seller request, exchange, and review critical documents to verify claims and evaluate key aspects of the transaction before closing. Buyers and sellers shouldn’t neglect this step as it allows both parties to assess factors that can significantly impact the purchase price or even the decision to proceed with the transaction at all. For buyers, due diligence offers a chance to uncover any potential risks or liabilities that could affect the investment. For sellers, it provides an opportunity to validate their business’s value, resolve any potential issues before closing, and evaluate the buyer if needed. In this blog, we will explore the due diligence process from both perspectives.
Buyer’s Considerations
For a buyer, due diligence gives the buyer confidence that the business is worth the sales price and has no undisclosed liabilities or operational risks. While there is no formal checklist that defines the due diligence process, buyers generally request a comprehensive list of information regarding the financial, legal, and operational health of the business.
Financials. The financial health of a business is one of the primary focuses of due diligence. The buyer’s list of information to consider should include the following:
- Financial statements for the preceding 3-5 years (ex. profit and loss statements, balance sheets, and cash flow statements)
- All inventory and assets
- Tax documents (EIN, Tax returns, any resolved or unresolved notices from the IRS)
- All debts and liabilities (ex. existing loans, liabilities, and obligations)
- (When applicable) Debt satisfaction documents and releases of any security interests on business assets
Legal Compliance. The buyer should ensure that the business is in good standing under federal, state, and local law, including any applicable licensing boards. Key areas of review include:
- Secretary of State documents (Articles of Organization, Annual Reports, Certificates of Good Standing)
- A list of all pending or past litigation, proceedings, or claims made against the company
- Ownership of Intellectual Property (IP)
- Permits, licenses, and any other document required for applicable regulatory compliance
Operational Considerations. The buyer should also consider various operational components concerning a business. These include:
- Title documents granting the business ownership over major assets
- Internal documents to show that the sale is authorized (operating agreement and company consents)
- Contracts and agreements (ex, lease agreements; utility agreements; customer, client, supplier, and vendor agreements; and employment agreements)
After compiling this information, the buyer should thoroughly review and consider the implications of the information provided. For example, if the buyer discovers a title defect in the seller’s ownership of a major asset, the buyer could negotiate a lower purchase price or require the seller to cure the defect before proceeding with the sale. Additionally, accompanying all of these foregoing requests, the buyer should also require that the seller represent and warrant that the information it furnishes in response to the request is accurate and complete.
Seller’s Considerations
From the seller’s side, due diligence is primarily about preparing for a buyer’s scrutiny and ensuring that the business is ready for sale. The goal is to present a clear, accurate picture of the business’s value and to address any issues proactively. To this end, the seller should organize financial records; confirm compliance with applicable laws and regulations and resolve any legal concerns; settle any ongoing litigation if possible; and review and compile contracts setting forth ongoing company obligations.
While the seller is primarily concerned with providing documents requested by the buyer, in some cases, the seller may also want to assess the buyer. For example, if the buyer is the owner of a closely held
family business, it likely has a sentimental interest in the ongoing success and reputation of the business. The seller could reasonably request information to assess the buyer’s capability, background, and reputation. Such information might include:
- Proof of funds or financing
- Documentation of the buyer’s industry experience and business track record
- A business plan or presentation of the buyer’s operational intentions
- Proper licensing and credentials (if applicable)
Conclusion
Due diligence is a critical part of any business sale or purchase. From the buyer’s perspective, it ensures that they understand the risks and rewards of acquiring the business, while for the seller, it’s about making sure that they’ve addressed any potential issues that could delay or derail the sale. Proper preparation and transparency from both sides lead to smoother transactions, helping to ensure that the deal closes successfully. By working closely with legal, financial, and business advisors, both buyers and sellers can navigate this complex process with confidence.
Contact Skufca Law at (704) 376-3030 today for more information or to discuss buying or selling a business. Stay tuned for the next blog in the Buying and Selling a Business series to learn about executing the deal.