Is Your Buyer Legit?

When selling your business, it's important to do your due diligence when researching potential buyers. Don't be hoodwinked.

By Mike Handelsman | Jul 18, 2012

An easy definition of due diligence is "serious investigation."

In almost all sales, due diligence is a condition of the buyer's offer. Only after determining that your business meets the buyer’s expectations - or that problem conditions have or will be satisfactorily addressed - will the buyer remove the due diligence contingency and close the deal.

During due diligence, as the seller you need to be ready on two fronts:

You need to be prepared to provide access to all the information the buyer will want to examine.
You'll want to be ready to simultaneously examine your buyer's financial condition and managerial experience, especially if you'll be carrying a seller-financed loan or agreeing to accept deferred payments for a portion of the purchase price.

Step 1. Assemble the documentation you'll need to provide.

Use the following checklist of information likely to be required by the buyer during due diligence:

Description of Material Likely to be Requested During the Buyer's Due Diligence
	Corporate or Schedule C tax returns for Past 2-3 years, allowing buyer to verify the revenues shown on financial statements.
	Business financial statements for the current and past 2-3 years including income statements, balance sheets, current cash flow statement, each presented in formal, professionally reviewed reports following industry standards. If you don’t have these materials, you should speak to your accountant, broker or another professional to get help in preparing them.
	Annual owner's cash flow or seller's discretionary earnings statement that recasts your most recent annual income statement to reflect revenues and all essential operating costs without extraordinary, one-time or discretionary expenditures, therefore accurately presenting how much money the business actually generates for the benefit of its owner.
	Financial trends and ratios including such information as revenue and profit growth trends.
	Accounts receivables/accounts payable lists
	Inventory list including value
	Major equipment and furnishings lists including value.
	Supporting financial information such as inventory turnover rate, receivables collection rate, and current or liquidity ratio.
	Current building lease including information on lease duration and transferability
	Fixtures, furnishings and equipment list indicating all items included in the sale, along with photos of major items, titles confirming ownership, lease and maintenance agreements, and depreciation schedules from most recent tax return.
	Copies of contracts and agreements with employees, customers, suppliers, distributors and others.
	Intellectual property documentation for patents, trademarks and other items, each showing ownership by the business rather than by individuals.
	Management and operational documentation including procedural manuals, product and pricing lists, other reports and agreements.
	Staffing records including list of employees with hire dates, salaries, contracts, and benefit summaries; description of employee benefits plan, organization chart and employment policy manual.
	Client information including information on transferable databases.
	Supplier and distributor lists including relationship descriptions and agreements.
	Business and marketing plans or summary descriptions.
	Business formation documents.

Step 2. Keep your sale intentions confidential while helping the buyer examine your business.

Due diligence requires careful management on your part. The buyer will want to meet and interact with staff and business clients and suppliers before you're prepared to make your sale plans public, so be ready to introduce the buyer in a manner that doesn't set off questions or fuel rumors.

If necessary, consider revealing your sale intentions to a very few key managers if you and the buyer require their help during due diligence. Seek an agreement with the buyer that these top-level employees will be offered bonus compensation for assisting in the sale process and transition. When sharing the news with these select staff members, stress the buyer's strong qualifications and positive plans for the future of your business. At the same, convey the due diligence timeline and the importance of keeping the sale confidential during that period.
Your broker, if you're using one, or your accountant can be a key resource during due diligence. Their offices can serve as a repository for the documents the buyer needs to access. They can also be the place where you and the buyer meet in order to reduce on-site presence and questions in your own business setting.
Confirm with the buyer how to contact you, likely through the email address and phone number you established specifically for sale purposes. Your aim at this point isn't to keep your business identity confidential - as it was during the initial stages of your marketing effort - but rather to keep the buyer's interactions less visible to customers, vendors and staff members.

Step 3. Be prepared for the scope of the buyer's investigation.

The buyer will likely want to research and examine the following aspects of your business:

Financial condition, looking beyond previously provided financial statements to assess financial management and growth potential.
Business operations, including how easily your production and other processes will transfer, the nature and transferability of your client base, billing and collection procedures, details about your staffing and management, your marketing plan including current and proposed marketing efforts.
Legal issues, including information on legal obligations or potential problems ranging from pending litigation, pension liabilities, claims, tax audits, zoning issues, and a wide range of other possible issues that your attorney can help you list and prepare to discuss.

Plan to devote significant time to assist with the buyer's investigation. Plan also to invest in the services of your accountant and attorney, who will help you determine what information to divulge and how to protect confidentiality if (and likely when) the buyer requests sensitive financial or other information to be shared with third-party reviewers.

Step 4. During due diligence, further investigate the capabilities of your buyer.

Especially if you're accepting part of the purchase price through deferred payments, due diligence gives you one more chance to verify the ability of the buyer both to make payments and to run your business in a manner that assures its success.

Obtain the buyer's personal financial statement and credit report. You can obtain this information through your broker, if you're using one, or on your own. Then ask your accountant to review the information to examine the buyer's financial strength.
Conduct an online search for the buyer's name to uncover publicity items and facts the buyer might not have shared.
Ask for and interview personal, financial and business references you can contact in an effort to discover whether the buyer presents a management or loan risk. Confirm with the buyer how to introduce your request if mutually you decide not to reveal purchase intentions, perhaps by telling the reference you're conducting reference checks on a person interested in a top-level position with your business.
Interview the buyer regarding plans to dramatically alter your business, including changing its location, product line, pricing and staffing. This information will help you determine whether you believe the business is likely to succeed, and therefore earn the money necessary to make deferred payments of the purchase price. It will also help you determine whether the buyer's plans are consistent with the assurances you have recently given or are hoping to give your established staff and customers.

Step 5. Be patient.

The buyer's due diligence investigation can easily take a month, and longer if your sale involves the transfer of stock (and therefore all known and unknown liabilities) or if the assets being acquired are difficult to examine and evaluate. The due diligence timeframe will likely be preset in the buyer's letter of intent, so you'll know what to expect. Still, it may feel prolonged and the investigation may feel intrusive and tiring. But it's necessary to get you to the next stage, which includes final negotiations, sale closing, and the transfer of your business.

In next week’s installment of “Selling Your Small Business” we’ll discuss what is covered in a purchase and sale agreement.

Editor’s Note: This article is the nineteenth piece in a series taken from BizBuySell.com’s Guide to Selling Your Small Business. The guide is a comprehensive manual to help small business owners maximize their success when the day to sell arrives. Each Wednesday, Inc.com will publish a new section of the guide outlining BizBuySell.com’s best practices, from the initial planning stages of a sale all the way through negotiations and post-sale transition.