RSM Resources

Due diligence in the sale of a business may seem to inherently focuson the needs of the buyer. After all, as part of due diligence, theseller must open its books to the buyer for close examination. But duediligence can also protect a seller’s interests — for example, aseller’s strategic approach to due diligence could help justify thevalue of a business and strengthen an attractive offer.

Duediligence typically begins when a seller and buyer complete theirinitial negotiations and sign a letter of intent for the purchase of acompany. It gives the buyer access not only to financial disclosuresbut to human resources, tax, environmental and legal information. Thebuyer and seller may have competing interests — for example, the buyerwants as much information as possible while the seller may want tosafeguard competitive information — but both can benefit from acomprehensive due diligence process.

For the buyer, duediligence provides the opportunity to confirm the accuracy of theseller’s disclosures. It also helps the buyer identify any potentialconcerns to address in the definitive purchase agreement. Examples ofsuch concerns include the assumption of noncompete obligations,questionable receivables and pending government approvals. The processmay also help the buyer plan to integrate the business into otheroperations.

For the seller, due diligence helps determine anyobstacles that could delay reaching a definitive purchase agreement andtimely closing. For example, the process may turn up additionalinformation the seller must disclose. Due diligence can also help aseller strengthen its negotiating position by establishing anappropriate value and prepare the business for ownership transition.

Seller’s obligations in due diligence

Whetherthe buyer is a competitor, supplier, private equity group or otherparty, due diligence requires the seller to share information andrespond to the buyer’s inquiries. It’s essential that sellers berealistic about the time and other resources due diligence willrequire. A seller must:

• Open its books to the potential buyer, sharing public and proprietary information about its assets and liabilities.
• Disclose past or pending matters related to customers, employees, finances, legal actions, products, regulations and taxes.
• Respond to investigative inquiriesby accountants, attorneys, business consultants, investment bankers,tax specialists and other experts who represent the buyer.
• Collaborate in good faith with the buyer’s due diligence team.

Aseller may be inclined to safeguard certain information should the dealfall through and the information fall into competitive hands. However,both sides have to maintain trust in each other. If the due diligenceprocess breaks down, or if it is incomplete or handled improperly, bothbuyer and seller can face significant consequences and exposethemselves to unexpected liabilities — including the risk of a dealfalling apart. This risk, plus the magnitude and complexity ofdisclosures, generally require the seller to retain its own outsideexperts.

"There are all the frustrations of constantnegotiations and constant information flow," says Kevin Mulvaney, abusiness professor at Babson College. The process can especiallyoverwhelm small to midsized businesses and privately owned companiesthat aren’t regularly involved in mergers and acquisitions, he says.Mulvaney estimates that, for such companies, 50 percent to 75 percentof deals don’t succeed.

Sellers’ steps to successful due diligence

"Forsellers, the key to a successful due diligence can be summed up in twowords: No surprises," says David Vang, chairman of the financedepartment at the University of St. Thomas in St. Paul, Minn. Beforeconducting due diligence, internally audit your company to identify anyissues. The buyer shouldn’t uncover any problems for you.

Here are some other tips for sellers to consider as they prepare for due diligence:

• Hire a professional appraiserto evaluate your company and help determine an asking price. Anappraisal can also help uncover potential issues and identify actionsyou can take to enhance your company’s value.
• Obtain signed confidentiality agreements from all individuals involved in negotiations, including employees of the seller, the buyer and third parties.
• Expect to provide financial and tax recordsfor at least five years, along with documentation for any lawsuits orpending actions that involve your company, employees, customers orvendors. Make sure you have clear ownership records for all your assetsand property.
• Be open to the process and avoid theappearance of secrecy or defensiveness. As a seller, due diligencemeans presenting your company openly, in the best possible light, andmaking the process straightforward for the buyer.
• Be honest about any major issuesfacing your company. If you can’t resolve issues before selling yourbusiness, disclose them before entering into any negotiation.
• Establish a special team toprovide information during due diligence, and help all employeesunderstand their role during the process. A potential buyer likely willinterview your top managers, who should prepare to participate with apositive and professional attitude.
• Provide financial incentives to key executives to stay through or beyond the closing of any deal, to protect the value of the company before and after sale.
• Don’t lose focus on the day-to-day operationsof your company, the needs of your employees and the expectations ofyour customers. To maintain the value of your company, keep thebusiness running smoothly — even with the distractions of due diligenceand a potential sale.
• Keep an eye toward the future,especially by making a smooth ownership transition for employees andcustomers. Work closely with the buyer to convey your company’s cultureand communication needs so that you can minimize disruption and helpprotect the legacy you have built.

"The biggestmisconception I see among sellers is that they view due diligence as anegative," Vang says. A typical seller often worries about whichquestions potential buyers will ask and how they will perceive thecompany. Instead, Vang says, a seller should see due diligence as anopportunity to validate the value of the business and explain thestrategic decisions that have positioned the company for growth.

Throughfull and proper disclosure, you can make the case for the best pricefor your company and ensure the buyer understands the value of thebusiness. You can also help the buyer see how to maximize theinvestment and realize its potential — which might be worth a premiumwhen you strike a deal.