Due diligence: what a buyer will ask for, and how to be ready

What is due diligence in a business sale?

A business is priced on its risk profile going forward. A buyer who has made an offer has usually arrived at their number by working out what impact the risks they can see would have on the business. Due diligence is where they verify everything they already believe, and look again at every single part of the business to establish whether it will be the same, better or worse under their ownership once the current owner has gone.

It is not a fishing expedition for reasons to walk away. It is the buyer building enough confidence to hand over the money, and a well-prepared file makes that faster and less fraught for everybody.

How long does due diligence take?

Three to eight weeks for a business in the $1 million to $15 million range. Simple service businesses with clean accounts sit at the short end. Anything with property, plant, multiple entities, inventory or regulatory licensing sits at the long end. The single biggest variable is how quickly the seller can produce documents, which is why preparation matters more than almost anything else.

What will a buyer ask for?

Expect all of this, and have it ready before it is asked for:

• Financial. Finalised end-of-year accounts for three to five years, the profit and loss for the year in progress, management accounts, tax returns and GST returns, aged debtors and creditors, and the working capital cycle.
• Revenue. Products and services by revenue for recent years, customer revenue ratios and concentration, pricing history, and any customer contracts with their terms and expiry.
• Suppliers. Supply agreements, exclusivity or distribution rights, key supplier concentration, and terms.
• People. Organisational structure, employment agreements, any anomalies in those agreements, remuneration, leave liability, contractor arrangements, and which roles are genuinely owner-held.
• Assets. Plant and equipment schedule with condition and age, deferred maintenance, ownership versus finance or lease, stock on hand and what of it is obsolete.
• Property. The lease, term, rights of renewal, rent review mechanism, assignment clause, and landlord consent requirements.
• Legal and compliance. Company records, intellectual property and trademarks, licences and consents, insurance, health and safety records, and any current or threatened dispute.

Where do deals actually fall over?

Rarely on a surprise nobody could have predicted. Almost always on one of these:

• Earnings that cannot be evidenced. Add-backs claimed in the information memorandum that cannot be verified.
• Something the seller knew and did not disclose. The item itself is usually survivable. The discovery of it is often not, because the buyer stops trusting the whole file.
• Customer concentration found during due diligence rather than disclosed up front.
• Lease problems. A short term, no renewal, or an assignment the landlord will not consent to.
• Working capital. Disagreement about how much, if any, has to be left in the business at settlement, which is better resolved in the offer than in week six.
• Drift. Due diligence with no deadline loses momentum, and a deal that loses momentum usually dies.

What should I fix in the twelve months before selling?

If you have a year, this is where it goes:

1. Reduce owner dependence. Document processes, move key relationships to staff, and put a management layer between you and the daily operation.
2. Broaden the customer base, or contract the concentrated ones onto terms that survive a change of ownership.
3. Deal with the lease. Renegotiate term and renewals before you are a motivated seller.
4. Tidy the accounts. Take personal expenses out, evidence what remains, and write off obsolete stock.
5. Fix the deferred capital expenditure, or accept it will come off the price and price accordingly.
6. Get the contracts and consents into one place, current and signed.

Everything on that list raises the multiple as well as smoothing due diligence, which is why the preparation conversation is worth having long before the selling conversation.

What are warranties and indemnities?

Warranties are statements you make about the business as part of the sale agreement, such as the accounts being accurate or there being no undisclosed litigation. If a warranty turns out to be wrong, the buyer can claim for the loss. An indemnity is a promise to cover a specific identified risk, such as a tax position or a dispute already in progress.

They usually come with caps and time limits, and they are worth taking your solicitor’s advice on. The practical protection is disclosure: anything you properly disclose before signing is generally carved out of the warranty you are giving.

How do I keep control of the process?

Set a due diligence period with a date on it. Provide the information through one channel rather than piecemeal. Answer fast, including on bad news. And keep running the business, because the trading result during due diligence is itself part of what the buyer is evaluating.