The Process of Selling Your Small Business: Step Six - Due Diligence
Welcome to Step Six, Due Diligence, in the "Process of selling your business" on California Business Broker.com. Remember, the step occurs after the price, terms and conditions have been agreed upon by both parties but before the buyers deposit has been deposited and escrow opened.
For some reason many buyers and sellers are intimidated by this process. On this page I will explain why not only is due diligence a necessary and important step, but also how it can be informative and, in some, cases a fun experience.
Investopedia.com defines due diligence "as the care a reasonable person should take before entering into an agreement or a transaction with another party." Their definition continues "as essentially a way of preventing unnecessary harm to either party."
What actually occurs during due diligence varies widely depending on the size and type of the business that is being sold. For a small, main street business a one or two week due diligence period would suffice. For a large middle market-type transaction due diligence can involve weeks or months of audits, investigations and inquiries into the various aspects of the business. I will continue and discuss some general aspects of due diligence and how it applies to both the buyer and the seller.
BUYER'S DUE DILIGENCE
For buyers, the due diligence period is their opportunity to fully investigate the business that they are considering acquiring. Some examples of areas a buyer may investigate may be the business's financial records, the business's contractual obligation to vendors or customers, the business's personnel records, the condition of the business's equipment or facilities, the status and condition of the business's IT infrastructure and finally if this is a strategic acquisition, this is the buyer's opportunity to see how well this business will vertically integrate into another business entity.
Please note that this is not an opportunity for the buyer to test drive the business. It is not appropriate for a buyer to start making or requesting changes in the business, supervise employees or make any commitments on behalf of the business. Finally, this is the buyer's opportunity, if they haven't already done so, to bring in their attorney, CPA, financial advisor or business consultant in order for these persons to provide counsel as to the feasibility of the transaction.
Note that for the buyer's due diligence each party has their role. It is the buyer's responsibility to carry out due diligence. It is the seller's responsibility to provide the information and documentation that is requested and finally, it is the broker's responsibility to facilitate due diligence and coordinate all parties that are involved.
SELLER'S DUE DILIGENCE
Many business owners believe that the due diligence period is for the buyer only. This is simply not the case. A seller most definitely has a role in the due diligence process. Not only is it important that the owner be responsive to the buyer's due diligence investigations, but also that that the seller or business owner undertake their own investigation into the competence and quality of the potential buyer.
Many business owners are rightfully concerned about the fate of the business that they've created. Many business owners also want to conduct due diligence to make sure that their employees, customers and vendors continue to receive the same quality and caliber of care that they received under their leadership.
Seller due diligence is especially important in situations where the seller is carrying a note where there is an earn-out provision or where the seller retains some smaller portion of ownership in the business. If the seller is carrying a note then the seller must look beyond the financial capability alone of the buyer. That buyer's capability to own and operate their business and continue to have that business be successful, is crucially important. The seller's note may allow the seller to repossess the business if the buyer defaults - but it could be possible that there is nothing let to reclaim.
Note that for the seller's due diligence each party has their role. It is the buyer's responsibility to provide the information requested by the seller, lender, broker or escrow. It is the seller's responsibility to carry out their due dilligence. Finally, it is the broker's responsibility to facilitate due diligence and coordinate all parties that are involved.
BUYER AND SELLER DISCLOSURES
During the due diligence period this is also the time where buyer and seller exchange disclosure statements. I use standard CABB (California Association of Business Brokers) forms. The intention of these forms is to flush out any potential problem or concerns early in the process. If an issue exists it will be discovered eventually. The key is to identify any potential problem early in the process, to address it, and to either move on or move ahead.
If you are a successful business owner in the Southern California area and would like a professional business intermediary to guide your business through the due diligence process, I would like the opportunity to meet with you. Please contact me today.
Have a question about Due Diligence? Go to California Business Broker .com contact page.
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