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FAQs About Due Diligence

FAQs about Due Diligence

 


What does due diligence encompass?

Due diligence can encompass all aspects of the business.  After successful negotiations to reach agreement on the buyer’s offer to purchase the business, it’s the buyer’s opportunity to request and examine details to confirm that representations made during the selling process are verifiable.  In due diligence, buyers and their advisors are also trying to identify any downside risks that must be addressed when the transaction closes.  Or, if the risks are significant, the buyer may withdraw the offer.

Buyers and their advisors may look at all facets of the business, including legal/company aspects, detailed financial records, operational and managerial documentation, employees and employee benefits, revenue sources, backlogs and contracts, supplier and vendor relationships and agreements, fixed assets inspections, inventory evaluations, intellectual property, information technology, etc.  The extent of due diligence often depends on the complexity of the business.

 


How does a buyer perform due diligence? What should I expect?

Much depends on the complexity of the business.  We can help you prepare for due diligence by anticipating some of the buyer’s requests.

In general, buyers and their advisors will usually submit a list of requested documents.  They will also ask a number of, what will seem like, never-ending questions.  Documents that are provided and questions that are answered often lead to more documents being requested and more questions being asked.

It is not unusual for a seller to feel he is being personally attacked or to feel the buyer doesn’t trust the seller.  You should expect to experience that type of feeling at some point during due diligence.  But, it’s important to understand that buyers don’t want to intentionally offend sellers.  For buyers, it’s all business, not personal.  Often they are making the most significant investment of their lives and they’re trying to gather as much information as possible in a short  period of time.  Whereas in the offer stage, they’re confident and excited about the business acquisition, during due diligence buyers can be nervous as they try to reach their comfort level with the investment required to finalize the acquisition.  Buyer’s  advisors often focus on the negative aspects of the potential acquisition, which makes the buyer even more anxious.  It’s a big decision for buyers to make that final leap of faith to say to themselves “Yes, I’m going to do this.”

Our best advice is to try to put yourself in the buyer’s shoes.  Be understanding of their anxiety and the negative influences they may be receiving from their advisors.  Be forgiving when you feel offended.  Be honest, forthright and extremely cooperative at all times.  Be positive, because your ultimate reward (closing) is only 30-45 days away.  For an explanation of 9 ways to be prepared for due diligence, read this article from the How to Plan and Sell a Business website: Inadequate Preparation for Due Diligence.

 


Why do so many deals fall apart after due diligence?

We believe that failure to anticipate and resolve potential problems before an Offer to Purchase is mutually agreed to is why so many transactions die in due diligence.  In other words, many potential transactions are doomed to failure because issues that could have been identified and resolved were deferred, supposedly to be addressed or resolved during due diligence.  We believe in tying down a lot of details in the Offer to Purchase Agreement.  To us, it makes no sense to allow due diligence to occur if known problems have not been adequately addressed in the Offer to Purchase Agreement.

There are numerous things that can lead to a failed transaction during due diligence. However, a good broker can anticipate and address potential problems before they become deal-killers.

It’s important that the seller disclose any known negatives in the front-end of the selling process.  As mentioned in the answer to the previous question, buyers are understandably nervous when making an acquisition, and if they discover an undisclosed negative problem during due diligence, they lose trust in the seller and the transaction is not likely to close after a buyer no longer has faith in the seller.  It’s important not to have any “skeletons in the closet” because many transactions fail to close when the skeletons are found.  Read this article:  Trust Issues from Inadequate Disclosures before Due Diligence.

 


Do I need my attorney or accountant to be involved in responding to due diligence?

For legal issues, yes you will need your attorney to be available to help you respond.  You will need your accountant’s involvement if you are unable to provide the financial records requested or you are unable to respond with adequate explanations to questions about your financial records.

 


Will the buyer’s lender perform due diligence on my business?

The buyer’s lender will perform due diligence on the buyer’s background and financial capabilities and also performs due diligence on the company to be acquired.  However, in most instances, the lender’s due diligence requests will be channeled through the buyer.  The lender’s approval of the acquisition loan may contain contingencies such as a lease term that matches the loan term, or a requirement for partial seller financing.

 

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If you have a question, send an email to jim@bizowneradvisors.com.

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