Signing a letter of intent can feel like the finish line. It isn’t. What follows is due diligence, where the buyer checks your business against everything they’ve been told so far. It’s demanding, and it’s where many deals lose value or stall. The good news is that most of it can be prepared for.
What due diligence is for
Due diligence lets the buyer, their lender and their advisors confirm the business is what it appears to be. They want to know the earnings are real, the assets exist and the contracts say what you’ve said they say. They’re also looking for liabilities that haven’t been disclosed.
For the buyer, it’s risk management. For you, it’s a stretch of heavy information requests while you still have a business to run. It’s also when unresolved issues are most likely to turn into a lower price.
When it starts and how long it takes
Diligence usually begins once you’ve signed a letter of intent (LOI). Most LOIs give the buyer a period of exclusivity, so you can’t talk to other buyers while they do their checks and the lawyers draft the purchase agreement. That’s why delays tend to favour the buyer: the longer it runs, the fewer options you have.
How long it takes depends on the size of the business, how organized your records are and how the buyer is financing the deal. Plan for weeks at the very least, and often a few months. In Kingston’s sale process, diligence comes after buyer screening and the LOI, and we manage the data room and coordinate the reviews with your accountant and lawyer.
What buyers look at
The scope varies with the business, but most reviews cover the same ground.
Financial
Several years of financial statements, monthly results, how steady and repeatable the earnings are, your normalization adjustments, working capital and debt. On larger deals, buyers often hire an accounting firm to do a quality-of-earnings review.
Tax
Your filing history, any open assessments, and payroll and HST compliance. The buyer will also look at how the proposed deal structure is taxed.
Legal
Corporate records and minute books, share ownership, key contracts, leases, permits and licences, any lawsuits or claims, and employment matters.
Customers and operations
Customer contracts and concentration, supplier relationships, pricing, equipment and facilities, systems, and the people who run things day to day.
Get your documents in order early
Documents are usually shared through a secure online data room, organized by topic so the buyer’s accountant and lawyer can work through it at the same time. A tidy data room speeds things up and tells the buyer the business is well run. A messy one creates questions and delays, and it plants doubt.
You can do much of this before you ever go to market. A good starting list:
- three to five years of financial statements and tax filings that reconcile with each other;
- current interim results and a written list of your normalization adjustments, with support;
- material customer and supplier contracts, leases and licences;
- corporate records, share registers and minute books;
- an employee list with roles, pay and any key agreements;
- a summary of any litigation, claims or regulatory matters;
- an equipment and asset list, with age and condition where relevant.
Sensitive items, such as customer names, are usually released in stages once a buyer has shown they’re serious. Our guide to preparing a business for sale covers the longer runway.
When the buyer finds something
Not every finding means a lower price. Some issues are cleared up with an extra document. Others are handled in the purchase agreement, through an indemnity, a holdback of part of the price or a condition that has to be met before closing. Findings that change the buyer’s view of earnings or risk can lead to a renegotiation.
If there’s a problem, tell the buyer before they find it.
Issues you raise early, with context and a proposed fix, are usually treated very differently from ones the buyer uncovers on their own. Diligence rarely turns up things an owner didn’t know about. More often it turns up things the owner hoped wouldn’t matter.
Keep running the business
The business has to keep performing the whole way through. Buyers and lenders watch monthly results closely during diligence, and a dip while you’re buried in requests is a common reason for a price to be reopened.
Before diligence starts, decide who on your team will handle day-to-day decisions. Set aside regular blocks of time each week for buyer requests rather than answering them all day long. Bring your accountant and lawyer in from the start, and deal with each issue as it comes up instead of letting a pile build toward closing.
General information for business owners and buyers, not financial, legal, tax or accounting advice. Any examples are hypothetical.
