Preparing a business for sale: the due diligence process

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05 November 2019

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Acquisitions and Disposals

Before a buyer signs on the dotted line, they’ll want to know as much detail as possible about the company they’re purchasing. So running a smooth due diligence process – and having access to detailed numbers, records, agreements and documentation is a critical final stage in the process of selling your owner-managed business.

In this four-part series, we’ve covered the core elements needed to prepare your owner-managed business for a sale.

In this final part, Paul Simmons, Senior Partner at Haines Watts Slough, explains the importance of management information and what to expect from a due diligence process.

A painful (but necessary) part of the sale

As the current owner of a business, they key thing to understand about a sale due diligence process is that it will feel at least five times more painful than any seller has planned for.

Due diligence is more time-consuming, and more detailed, than you could ever expect. The danger is that you may be unable to continue running the business effectively, because your time is completely consumed by dealing with due diligence requests.

As we mentioned in Part 3 of this series, housekeeping is a vital part of sale preparation. But if there’s any housekeeping that you haven't done, you'll have to backfill that painfully and quickly, whilst also answering all the detailed due diligence questions.

So be aware of this, factor it into your timescales and prepare yourself for that pain.

Keeping the business moving forward

Realistically, due diligence will take at least six months to complete. But you also need to be careful that you’re still focused on keeping the business running and hitting targets.

As part of your regular strategic planning, you’ll have set budgets and targets for the company to meet. If you miss these targets, while the due diligence is happening, the buyer is highly likely to offer a lower price as a result.

So, in the period between terms being signed and the due diligence process, you've got to hit the numbers. Otherwise, you're inviting the buyer to come back and say, 'We gave you the price based on you hitting these numbers – and you’re not hitting them!'.

You also need to continue implementing new projects, so you’re keeping the wheels turning and adding value to the company and its future prospects.

Having a healthy financial position

A healthy financial position is another key element that the buyer will want to see during the due diligence activity – being in control of your finances is critical.

In essence, your financial position is going to be scrutinised in two distinct ways:

Firstly, the buyer wants to see evidence of a good historical track record when it comes to the company’s profits and cashflow position.
Secondly, the buyer wants to see a profit forecast, so they can understand the potential for the company to generate profit in the future.

The key part of any profit forecast is knowing what the assumptions are – and whether they’re dependable. The buyer will be checking whether your forecast is sufficiently cautious, robust, has the right balance, and whether the numbers are achievable.

Drilling down into the profit numbers

Once your buyer has the bigger picture on your financials, they’ll want to drill down into detailed information. A common area to look at will be gross profit.

A buyer is likely to want massive detail on the profit figures. This means you need to be able to produce reporting around gross profit by customer, service line, month or even by product.

The question you must ask yourself, as the seller, is whether you've got sufficient systems to provide that type of detail. Because, often, that's not the case.

At this point, you have a choice to make:

Do you invest the time and money required to produce the detailed reporting your buyer is requesting (adding a cost that will come out of the sale price)?
Do you go back to the buyer and tell them you can’t provide this information, as your systems aren’t set up to provide this level of reporting?

In most cases, it’s in the seller’s interest to answer the buyers questions in as much detail as possible. And, if you plan far enough ahead, there are simple changes that can be made to your accounting system to allow you to record cost of sales and provide that information.

Warranties and indemnities

An important part of your sale and purchase agreement – the legal contract that sets out how much is being paid and when – will be the 'warranties and indemnities' section.

These warranties and indemnities are given by the seller on various business matters. You may give a warranty that all tax returns have been filed on time, or that if a tax bill arises pre the sale point, you will pay for it.

Warranties and indemnities can all result in costs, so your aim should be to limit the issues that could arise. Doing your housekeeping effectively means that your buyer has fewer issues to raise and include in this section.

Minimising your exposure in this way makes for a far smoother (and less costly) sale.

Centralising your key records and information

Tidying and decluttering is part of the housekeeping process, but making sure your tidy, organised records are easy to access will help the due diligence run more smoothly.

If you’ve gone to the trouble of making sure all employees have got up-to-date contracts, or that shareholding records are current, make sure to put them all in one place.

With online storage it’s never been easier to collate, organise and access your information. So, get all your records into a centralised storage area and make it quick and easy to pull stuff out – rather than having to chase around looking for a needle in a haystack.

Controlling the emotional impact

When you've been asked the same due diligence question for the fourteenth time, tempers can start to flare – but keeping the emotion out of the process is key.

The temptation is to say ‘I can't be bothered with this!'. But if your buyer sees this lack of engagement they’re liable to pick up the phone and tell you that, actually, they can't be bothered with the sale either. So, you have to keep emotion out of it and keep plodding through – you've got to answer these questions, however tedious they may be.

It's perfectly reasonable to challenge the buyer on whether they're asking the right questions. But having gone through the challenge process, one just needs to get on with it and get the answers. And that's even if there's a cost involved.

The value of proper planning

You don't wake up and say 'I'm going to sell my business tomorrow!'. At the very least it will take you a year to sell up, and it’s far more likely to be a three to five-year process. With this in mind, it’s vital that you prepare your business for sale in a methodical way.

As we’ve examined throughout this series, to create a successful sale you must:

Make a sale business plan – and have a very clear plan around timescales, what you’re selling and what you want to achieve from the sale.
Enhance the quality of earnings – by defining and enhancing the core value in the business.
Do your housekeeping – so you’ve carried out the tidying and decluttering required to deliver a lean, organised and efficient business to your buyer.
Prepare for the due diligence process – by answering the right questions, providing the information that’s required and limiting your exposure to any liabilities and costs.