Essentially, due diligence is a fancy term for an inspection. It can be as simple as a couple of hours reviewing the books, checking with the state, and verifying equipment leases and serial numbers; or it can be a complex, many months-long “deep dive” into lease agreements, legal contracts, debt arrangements, employee records, equipment valuations, etc. So, depending on the size and complexity of the transaction, expect the due diligence process to take anywhere from 4 to 12 weeks.

You can think about due diligence as being similar to your mindset and actions when you prepare to buy a car. As a prospective buyer, you want to open the hood, kick the tires, take it for a ride, and maybe even have a professional look at it to see if everything is as you thought it would be.

The due diligence process usually takes place as the financing documents and legal agreements are being put together. Be forewarned. The due diligence process can get very touchy and awkward, especially when a competitor is buying you out. In the interest of full disclosure, you need to show the buyer what he or she needs to verify your information to the extent you feel comfortable doing so and within the confines of any non-disclosure or confidentiality agreement you have with the prospective buyer—especially when your buyer is a current or potential competitor.

Unfortunately, there are no laws governing the minimum requirements you need to provide the buyer or what he or she can access. Typically, a buyer requests in writing what he or she wants to review before the due diligence process begins. The seller reviews the list and then negotiates based on what is available and what he or she feels comfortable sharing. A seller may counter with suggestions on how to answer any concerns raised by the buyer, and can deny requests that feel too personal or unnecessary.

An example of a touchy situation is a buyer’s request to meet your key employees. Most sellers try not to tell employees about selling the business until the deal is done. However, buyers may want to meet and interview these key employees to make sure they will stay on after the sale and to confirm they are as valuable to the business as advertised.

If and when such a meeting takes place is a negotiation to be handled between the two parties—a negotiation that should be worked out early in the process. Generally, a good seller opens his or her office, books, and policies to the buyer, effectively letting the buyer see whatever he or she wants to see. At the same time, the buyer needs to be sensitive to privacy, timing, and relationships the seller needs to maintain.

A seller wants as little disruption as possible during the due diligence process so he or she can focus on running the company until the hand off. The buyer, on the other hand, needs to get enough information and validation so that once the company is purchased, he or she can continue to execute at the same level or higher.

The bottom line is, whether you are the buyer or seller, you need to be reasonable and fair. Too many good deals are blown up at this stage due to emotions. Sellers often want to hold back information they feel is unnecessary and buyers start distrusting sellers. Within reason, provide the buyer what he or she needs and try to complete the process as quickly as possible to minimize disruption. After all, a buyer doesn’t need to know how every piece of the car engine works in order to drive the car off the lot.

What Do Buyers Want to See?

At the due diligence stage, buyers are usually interested in the following items:

• Financials and Taxes – A buyer will want to see the last 2 or 3 year’s worth of tax returns, confirm they reconcile to the financials, and then review all supporting documents for the financials provided. A buyer will want to compare revenue recognition issues from year to year and try to determine if there was any financial “dress up” in the original presentation.
• Litigation – A buyer will want to see any past, current, or pending litigation, especially in areas of employees, products, and contracts.
• Employees – A buyer will want to see pay schedules, lengths of service, benefit packages, job descriptions, organizational charts, contracts with key employees, etc.
• Permits and Licenses – A buyer will need to review any permits to determine if they are transferable and in good standing. These can include universal permits such as business licenses and sales permits, or permits specific to the operation of the business such as environmental permits, discharge permits, air quality inspection reports, fire safety inspection reports, OSHA inspection reports, etc.
• Leases – A buyer will want to review rental leases, along with the terms, on all buildings, equipment, autos, and land.
• Customer Base – A buyer will want to review the histories of the top customers and the percent allocation for each client. A buyer will need to understand the relationships, contracts, and any future sales opportunities.
• Liabilities – A buyer may run credit checks on the company and review debt payment schedules and vendor/supplier lists.
• Assets – A buyer will want to look at all inventory, office equipment, trucks, tools, etc. to verify they exist and to confirm price allocations per unit.
• Owner Write Offs – A buyer will want to review how owner perks such as meals, travel, entertainment, etc. were handled in the financials to make sure any re-casted financials are reasonable.
• Corporate Structure – A buyer will review the corporation status with the State and verify all corporate documents are current and up-to-date.
• Insurance – A buyer will want to understand how the business is protected against future liabilities.