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The Process of Buying or Selling a Business: A First-Time Seller’s Guide to Due Diligence

Selling your business is not just about finding a buyer and agreeing on a price. Once the basic terms of the deal are agreed upon in a letter of intent, the buyer will want to sift through your business and legal records with a fine-tooth comb. This meticulous review of your business, from contracts to customer lists, is called due diligence. Due diligence allows the buyer to uncover risks when buying a business.

Keep sensitive information confidential: Due diligence involves giving the buyer information you wouldn’t want competitors to know, like the identities of your customers and the terms of your contracts with them. Having the buyer sign a non-disclosure agreement (NDA) before you disclose any sensitive information helps keep it confidential.

Due diligence typically unfolds like this:

  1. The buyer sends the seller a due diligence request list, which contains questions and requests for documentation relating to the seller’s business.
  2. The seller responds to the buyer’s requests and uploads documents to a data room. A data room is an online document storage platform where due diligence material is reviewed by the buyer.
  3. The buyer reviews the seller’s responses and sends follow-up requests if necessary.
  4. If an issue is found, the buyer and seller will negotiate a solution.

In some circumstances, a seller might also conduct due diligence on the buyer’s business. For example, if the buyer is giving the seller equity as part of the purchase price, the seller may want to learn about the buyer’s business.

The due diligence process may feel intrusive and is often an obstacle to closing. However, due diligence can be an opportunity for the seller to showcase its business and develop trust with the buyer to help get the deal closed.

The Due Diligence Request List

A due diligence request list contains questions and requests for documents relating to the seller’s operational, commercial, and financial position and performance. These are types of business due diligence that help the buyer determine the value of the business and business risks associated with acquiring and owning the business. A seller should expect to receive requests for items such as asset lists, employee lists with salaries and job descriptions, contracts with customers and suppliers, product and service offerings and pricing, bank accounts, financial statements, tax returns, accounts receivable and payable, debts, lines of credit, and other business matters.

Importantly, the buyer will also want to confirm you have rights to the assets you represent as owning and uncover potential liabilities associated with the business. This is called legal due diligence, which is a major focus for the buyer’s counsel. A seller will typically receive requests for items such as:

  • Corporate documents, including incorporation or formation records and related shareholder or member agreements, capitalization tables, meeting minutes, and other resolutions.
  • Contracts with customers and vendors.
  • Employment policies and agreements, including contracts with employees, contractors, and consultants, handbooks, and non-compete and non-solicitation agreements.
  • Intellectual property, including trademark, copyright, and patent registrations, trade secrets, and other proprietary information.
  • Litigation and potential litigation.
  • Licenses and permits used by the Seller.

These are example categories, and an actual diligence list will be very comprehensive with the intent of reviewing every aspect of the business. Also, the buyer will have additional requests if the seller is in a specialized industry. For example, if the seller is a software company, the buyer would want to identify the proprietary software the seller owns. Below is an example of some requests a seller of a software company should expect to receive:

Example – Software-Related Diligence Requests

  • List all proprietary information technology (IT) products and services of the Company (collectively, “Company Products”).
  • Indicate whether each Company Product is or has been in the past five years:
    • licensed, sold, or offered for license or sale by the Company, together with revenues received by the Company with respect to such Company Product;
    • maintained and supported, but not licensed, sold, or offered for license or sale;
    • under development by or for the Company and planned to be offered for license or sale by the Company within the next 24 months;
    • used internally in connection with the design, development, manufacture, or delivery of any key products or services of the Company, with a description of the relevant products or services; or
    • used internally solely for “back office” or “front office” administrative functions of the Company, with a description of the function provided by each such Company Product.
  • Provide copies of any and all material royalty, license, franchise, distribution, affiliation, programming, and similar agreements relating to the use of the Company Products by third parties.

Preparing for Due Diligence

Preparing for due diligence makes the diligence process more efficient and reduces the likelihood a diligence issue delays closing. We’ve seen that sellers who do the following in advance are more prepared when it comes time to respond to due diligence requests:

  • Identify executives, employees, financial advisors, or other advisors who will help respond to due diligence requests. For example, your accountant can help prepare financial statements requested by the buyer.
  • Gather and organize key documents in advance of due diligence. This will help you identify gaps in your record-keeping. For example, contracts (with customers and vendors), financial statements, legal filings, and licenses should be organized and named accurately.
  • You should also have your deal counsel conduct an initial review of your business and legal records. This will help identify issues that can be resolved before due diligence begins or strategize ways to disclose them to the buyer.

Responding to Due Diligence Requests

Once the buyer sends the due diligence request list, it will expect to see the seller’s progress quickly. At the same time, you may be operating the business and participating in negotiations of other deal documents like the purchase agreement. Managing these tasks at the same time can be overwhelming. Here are some ideas to make responding to due diligence requests as painless as possible:

  • Keep the data room organized when uploading documents. Naming files accurately and avoiding duplicates will keep diligence review efficient for both sides. If the data room is disorganized, the costs of examining disclosure materials can compound quickly.
  • Communicate effectively with your deal counsel. It’s common to encounter issues during due diligence, like not being able to find a contract or having gaps in your corporate records. Communicating with your deal counsel about those issues can prevent them from becoming a barrier to closing.
  • Include complete responses when possible. Partial responses will almost always result in follow up requests from the buyer. These back-and-forth exchanges increase costs and can delay progress on other deal documents. If you need time to find additional information, you can indicate that to the buyer so it is aware you’re trying to locate it.
  • Be honest and transparent. Concealing issues with your business could result in the buyer walking away from the deal or even liability post-closing. You should work with your deal counsel to ensure all due diligence responses are complete and accurate.

Summary

Responding to due diligence requests quickly and accurately keeps a deal moving forward efficiently. Having skilled advisors on your team can help you manage the due diligence process. The mergers and acquisitions practice group at Riggs Davie PLC counsels clients through deals on the buy-side and sell-side in a wide range of industries, including technology, health care, health tech, fintech, professional services, financial services, real estate, business services, manufacturing, and distribution. For more information about our services, please visit www.riggsdavie.com or contact our practice group by email at dealteam@riggsdavie.com.


This article is for general information only. The information presented should not be construed to be formal legal advice nor the formation of a lawyer/client relationship.

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