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A version of this article first appeared on AccountingWeb and can be found here (you will need to register to view this on AccountingWeb) 

In this article we take a look at the due diligence process on the sale of a business.  Most of you will be familiar with what due diligence is and many of you will appreciate that it is often a difficult process from which many buyers and sellers struggle to derive value.  We consider how it should be approached and give some tips for surviving it.

Is due diligence inevitable?
Any prospective buyer of a business should want to be as sure as possible that the business is worth what they are paying for it.  It’s therefore understandable that they will want to kick the tyres and carry out some investigations into the business, its assets and people.

If you want to sell your business it is possible that you will find a buyer who is willing and has the money to just write a cheque without doing due diligence.  However, especially in these economically difficult times, buyers like this will be few and far between.

We often find that even if some people on the buying side are willing to proceed with minimal due diligence (perhaps a director who is championing the deal at a commercial level) often they are unable to do so because others (funders, shareholders, the main board) require thorough due diligence.  So don’t just accept at face value any assertion that due diligence will be ‘light touch’ or ‘limited’ – make sure all stakeholders on the buying side agree with this.

What the reality of due diligence often is
Due diligence can certainly be a painful process for buyers and sellers alike: it can consume a lot of time and result in high professional fees.  We have been involved in plenty of deals where this has created friction between the parties: – "why is your lawyer/accountant asking this irrelevant question – can’t we just get on and sign the deal?","why is it difficult to provide this basic information which you should have at your fingertips?".

In addition, it’s a common complaint that the only persons who receive value from the due diligence process are the professional advisers who conduct it, with the sellers, buyers and target business having got little of genuine use from the process.

Collaboration not confrontation
Sellers should assume from the outset that any buyer is going to want to investigate every element of the business and will only proceed if it has all the information that it needs. If a seller does this then his interests are likely to be aligned with those of the buyer: they both have the aim of all relevant information being in the open.

A buyer who is invited to see everything about a business is likely to have confidence that the seller has nothing to hide and, as a result, trust between the parties should grow.  In contrast, if you have a seller who is unwilling or unable to provide information the opposite is likely to happen and it may actually mean that a buyer feels it needs to conduct more thorough due diligence.

Cracking old chestnuts 
Sellers are sometimes tempted to assume that a buyer won’t find out or won’t be bothered about a particular issue.  Sometimes this turns out to be right but, if it isn’t,  the consequences can be significant – the buyer can decide not to proceed or the deal terms can change significantly.

From a legal perspective, we find that the same issues come up time and time again which cause problems in due diligence.  Often these issues are ignored or overlooked until late in the sale process.  When this happens, mistrust between the parties can creep in and renegotiation of deal terms and price reductions become much more likely.  Whereas, if the issues are identified and dealt with up front it is often possible for them to be resolved in a way which does not disrupt the deal process or terms.

Examples of these types of issues include:

  • inadequate documentation for customer and supplier contracts
  • inappropriate employment contracts for key members of staff
  • for intellectual property rich businesses (such as those that develop software) inadequate evidence that the business owns/has the right to use intellectual property
  • dilapidations liabilities on leasehold properties which have not been provided for
  • irregularities with share capital, where legal formalities have not been complied with.

Five tips for surviving due diligence for sellers

  • Assume it will take time and be comprehensive. If sellers start with this mindset then they can prepare accordingly and are less likely to be frustrated.
  • Put yourself in the buyer’s shoes.  A seller should ask itself what questions a buyer is likely to ask and make sure that these questions can be answered.
  • Get organised early. Prepare early, well before potential purchasers are approached.
  • Resource it.  Assume due diligence will take time and then work out who is going to be responsible for fielding the different questions that will come in.
  • Present solutions.  If there is a problem area, either resolve it or present a solution at the outset.