The Due Diligence Phase: Preparing Your Business for Buyer Scrutiny

When you’re ready to exit your business, the thought of exposing the insider details to buyer scrutiny during the due diligence phase can cause a lot of apprehension.

First, know that it’s natural to feel protective and even defensive. You’re not alone in feeling this way. Most business owners have to grapple with the reality that soon, someone else will be poring over their financial records and critiquing the foundation they’ve worked so hard to build.

Second, recognize that this step in exiting your business is inevitable, but there are moves you can make to present your business in the best light and take a proactive approach to addressing any buyer concerns. The better prepared you are, the smoother the process and the higher the likelihood of securing a deal that both parties can feel confident in shaking hands over. 

Because there’s so much to consider when you’re preparing to exit your business by selling it, we’ll split our discussion of the due diligence phase into two parts. Today, we’ll cover 1) the buyer’s perspective, 2) financial preparedness, 3) operational readiness, and 4) legal and compliance considerations. 

Let’s get started!

Understanding the Buyer’s Perspective

Every buyer, whether it’s an individual or a massive conglomerate, approaches a business sale with their own objectives and concerns driving their decisions. 

Buyers are making a significant investment and possibly taking on a considerable risk. Their scrutiny during the due diligence phase is an opportunity to mitigate that risk, so it’s fair that they come to the table with many probing questions. That doesn’t mean that you have to go into the situation blind. There are some general rules of thumb that can help you understand where different types of buyers are coming from.

• Strategic buyers are typically competitors or businesses in a related industry looking to acquire assets that complement their existing operations. They will prioritize factors like similarities between customer bases and operations or folding in new intellectual property.
• Financial buyers generally consist of private equity firms or individual investors whose main concern is the return on investment (ROI). They’ll focus on your business’s financial health, growth prospects, and profitability.
• Individual buyers are often professionals looking to own and operate a business. They’re more likely to focus on things like your company’s public reputation and the learning curve they might experience in your particular industry. 

When you know where the buyer’s mindset is, you can tailor the due diligence phase to address their concerns and push forward the aspects of your business most likely to entice them.

Financial Preparedness

One of the first things buyers will want to look at is your books. They want to know that your business is financially healthy and has the potential to sustain that success into the future. 

At this point in the due diligence phase, your job is to get your finances in order and be prepared to transparently discuss them to alleviate any lingering apprehension by taking the following steps:

1. Document all transactions, no matter how minor, to give the buyer a clear picture of your business’s financial health and show them that there’s nothing to hide.
2. Get periodic external audits to identify any areas of concern you can address before the sale. Audited financial statements give your business more credibility by assuring buyers that a third-party expert has vetted the company’s financial standing, making them more inclined to trust the numbers.
3. Eliminate those “personal” expenses that many small to medium business owners tend to run through their business for tax purposes. Before presenting your financials to a potential buyer, you must clearly distinguish between business and personal expenditures.
4. Prepare a report showing how any business debt was used for growth or operations and a plan for settling that debt before the sale.
5. Review fluctuations in revenue and be ready to explain them, whether it’s due to normal seasonal trends or a one-time event. It’s unfair to the buyer to misrepresent the ebbs and flows they can expect from the business sale.

Operational Readiness

Even if your financials don’t present the most glowing picture of your business, your ability to demonstrate exceptional operational efficiency might be the “it” factor that turns a maybe into a yes. 

Part of your successful exit strategy should absolutely involve preparing for potential buyers to dig deep into how your business runs day-to-day and having clear, effective processes to drastically increase your business’s appeal. 

Start by documenting processes and procedures such as:

• Standard operating procedures (SOPs)
• Training manuals
• Technology and software documentation

Then, you’ll need to get your contracts and permits in order because any lapses in legal compliance will be a major red flag to buyers. Get everything up-to-date to avoid potential legal complications and prove that you’re running a legitimate operation.

Start by reviewing all of your vendor contracts, double-checking that they’re current and transferable so that your buyer receives the same terms and benefits post-sale.

Then, move on to employee contracts so that there won’t be a mass employee exodus once the business changes hands. Spend some time talking with anyone whose contract is approaching an end date so you can answer questions about whether the new owner will need to start hiring for key positions. 

If you want to create an even better selling point regarding the long-term stability of the business, show that you’ve encouraged employees to stay on after the business changes hands with contracts and incentives 

Finally, you’ll need to prepare your employees and second-in-command to handle the transition in partnership with the new owner. A strong management team will ease transition fears, especially if you, as the owner, are deeply involved in daily operations.

Legal and Compliance Considerations

Unfortunately, acquiring a business isn’t just about obtaining new assets but could potentially involve inheriting any liabilities. While minimizing unresolved legal issues is tempting, it’s your responsibility to go about the sale dedicated to transparency, even when the picture isn’t perfect. Trying to hide what’s going on behind the scenes will most assuredly stall the deal and erode any trust that you’ve built up with your potential buyer. 

Begin by gathering proof that any prior legal issues are resolved in full. Get together settlement documentation that clearly shows the final outcome, and you’re taking the right path to portraying your business as proactive and responsible. 

Then, move on to any IP associated with your business because assets like patents, trademarks, and copyrights add tangible value to the sale. 

You must be absolutely certain that they’re legally registered under your business’s name and current. Moreover, if you’re licensing out your IP or licensing from others, you need these agreements meticulously documented so your buyer can seamlessly continue operations. The same goes for any non-disclosure agreements (NDAs) in place to further boost buyer confidence.

Final Thoughts

We’ve already covered a lot, but it’s just the tip of the iceberg when you’re dealing with the due diligence phase of exiting your business. Next week, we’ll cover topics like reputation management, asset evaluation, and more so you feel well-prepared for the next step of your journey as a business owner. 
In the meantime, don’t handle exiting your business alone. Work with professional exit coach Lori Moen to set yourself up for the best-case scenario that ensures both you and your business continue to thrive long after you’ve signed the sales documents.