Selling a business marks a pivotal moment in any entrepreneur's journey. It's what all those years of hard work, dedication, and vision led up to. But making a successful sale is not without its challenges. Chief among them: due diligence.
Understanding and preparing for the due diligence process can make all the difference in a successful sale. A smooth due diligence process can significantly increase your likelihood of a successful sale, and even boost your business’s valuation.
Below, we’ll demystify the due diligence process so you can rest assured that you're well-prepared for what lies ahead.
What Is Due Diligence?
Within the context of buying or selling a business, the term “due diligence” refers to a comprehensive investigation of a business by its potential buyers. This process allows the buyer to verify your claims, assess risks, and determine if the purchase is right for them.
On the part of the buyer, this typically involves:
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- Scrutinizing a business’s finances
- Undergoing legal and regulatory compliance checks
- Performing operational assessments
- Analyzing market position, share, and opportunity
Buyers want to ensure they’re making a strong, informed financial and business decision.
But due diligence is not a passive experience for the business owner—or at least it shouldn’t be. There’s plenty you can do to make this process as painless as possible.
Due Diligence Checklist
Once you’ve decided to sell, preparing yourself (and your company) for the due diligence phase is a strong next step, as it’s one of the most important processes you’ll go through.
The following checklist outlines the key areas you should focus on during this self-audit.
#1: Early Preparation
Before the buyer ever starts their investigation, you need to lay a solid foundation. And what that foundation looks like might vary depending on the type of business you’re selling.
For example, imagine you're the owner of a successful software company preparing for sale.
In this case, you might start by gathering your financial statements from the past three years and organizing your legal documents, including customer contracts and intellectual property registrations.
You would also likely need a detailed list of employees and their roles, documentation about product architecture, and customer metrics such as churn rates.
While the specifics depend on your unique situation, here is a list to get you started:
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- Organize Financial and Legal Paperwork: Ensure you have at least three years of audited financial statements, including income statements, balance sheets, and cash flow statements. You’ll also want to have any legal paperwork regarding your business’s structure, contracts, ownership agreements, and other obligations. We’ll discuss this in more detail in the following sections.
- Create a Professional Data Room: Set up a secure digital repository for all relevant documents. This organized approach will streamline the process and impress potential buyers, making it easier for them to find the information they need.
- Engage an Exit Planning Consultant: Exit planning experts, like those at GSquared Partners, can help you prepare for the transition in detail. For example, a consultant can help identify potential red flags in your financials that could raise concerns during due diligence.
#2: Financial Due Diligence
During financial due diligence, buyers closely examine various financial aspects of your business. For example, if your software company has developed a popular project management tool, buyers will want to understand the revenue streams and cost structure associated with it.
Generally, buyers will examine:
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- Financial Statements: Income statements, balance sheets, and cash flow statements for the past three years help buyers assess your financial stability. If your financials reflect a strong, steady profit margin, this can be a significant selling point.
- Tax Records: Federal, state, and local tax returns help buyers understand your tax obligations and compliance status.
- Financial Projections: Quarterly financial projections for the next fiscal year paint buyers a picture of your business's potential for future growth.
- Quality of Earnings (QoE) Analysis: During this process, an independent accounting firm conducts a thorough analysis of your financial statements on behalf of the buyer. This analysis helps validate your financial health and may uncover any discrepancies.
#3: Legal Due Diligence
Legal due diligence involves verifying your business's legal standing and potential liabilities that the buyer would have to handle if they were to make the purchase.
They’ll typically look at:
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- Corporate Structure: Articles of incorporation, bylaws, and any amendments help buyers understand your business's legal structure.
- Contracts and Agreements: Buyers need to be aware of key contracts with clients, suppliers, and partners. These documents need to be up-to-date and reflect the current state of your business relationships.
- Intellectual Property: Buyers will want to interrogate the value and defensibility of your intellectual property by examining patents, trademarks, and copyrights.
- Compliance Issues: Documentation such as licenses and permits, audit paperwork, and internal controls show buyers that your business is compliant with all relevant regulations and laws. This includes any industry-specific regulations that may apply to your business.
#4: Operational Analysis
In operational analysis, buyers will assess how effectively your business operates. For instance, if your software company has a distributed team, they will want to know how you manage this structure.
They’ll examine areas such as:
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- Organizational Structure: This involves paperwork like your organizational chart and staff lists highlighting key personnel and their roles, helping buyers understand the expertise your company has to offer and where there may be skill gaps.
- Systems and Processes: Buyers study the software, workflows, and processes used to run the business, including any proprietary systems that give your business a competitive advantage. For example, if you have a unique project management system that enhances productivity, this can be a selling point.
- Inventory and Assets: A full inventory of all physical assets, including equipment, real estate, and product inventory, helps buyers understand the tangible value of your business.
#5: Commercial Analysis
During commercial analysis, buyers analyze your business's market position and growth potential. For example, if your project management software is expanding from small businesses to enterprise clients, buyers will want to understand your strategy for this transition.
They’ll focus on details like:
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- Market Position: Buyers will examine your relationship to competitors and industry trends to learn what differentiates your business from others in the market.
- Customer Base: Buyers examine your target audience, major customers and their purchasing history to assess your business's stability and growth potential.
- Growth Plans: Buyers will want to know how you plan to expand your business post-sale, so be ready to discuss future growth strategies and their viability.
- Key Metrics: Prepare data on any other KPIs not already covered, such as customer acquisition costs and retention rates. These metrics can provide insight into your business's operational efficiency and market viability.
Prepare for Due Diligence with G-Squared Partners
A smooth due diligence process helps you secure a successful business valuation and sale. Proper preparation and experienced guidance can make all the difference.
At G-Squared Partners, we specialize in helping businesses navigate both sides of the due diligence process. We can help you prepare thoroughly, anticipate potential issues, and present your business in the strongest possible light to potential buyers.
Don't leave the success of your business sale to chance. Contact G-Squared Partners today to learn how we can help you achieve a successful outcome in your business sale.
