Due diligence is the process by which potential buyers who have expressed a serious interest in the business (after submitting a letter of intent or a conditional offer) verify that the business is truly what they believe it to be.  With such a broad definition, its is understandable that business sellers don’t really know what to expect. The process is not standard and changes dramatically depending on the type of buyer, the industry, the size of the business etc.

In general terms the more sophisticated the buyer, the longer and deeper the due diligence. Large transactions, especially share purchase transactions require more sophisticated due diligence. Also, the more knowledge about the business the buyer has before signing a letter of intent or conditional offer the shorter the due diligence period. Whether the business seller (or Broker) should only accept a letter of intent from buyers who already have received extensive information about the business is always a dilemma. On the one hand, giving away confidential business information to a large number of potential buyers who simply expressed an interest in the business is very risky as it increases the chances of this information ending-up in the wrong hands. On the other hand, committing to a letter of intent from a buyer with very little knowledge about the company increases the chances of a deal falling through. A deal falling through does generally not help when trying to sell the business to other potential buyers.

Despite all the uncertainty regarding the due diligence process, there are some principles that if applied correctly can smooth up the due diligence process and increase the chances of reaching a deal:

1. There should remain some flexibility in negotiation during due diligence: if negotiations are too tight, deals generally don’t make it through due diligence. Buyers or sellers accepting reluctantly unfair terms and conditions have all the time to change their minds during the due diligence and deals generally fall through. A deal should be win-win where both parties receive a lot of value and are willing to give up a little bit more to save the deal.
2. Sellers should be upfront about the good, bad and the ugly about the business. It’s mach better  for the seller to loose a buyer before signing the LOI rather than during due diligence so let the buyer know in advance what to expect. Furthermore, it’s almost impossible to hide an important fact about the business to a savvy buyer. In this case honesty does pay.
3. Understand the buyer’s hesitations and deal with them. It’s perfectly normal that buyers show suspicion during due diligence. It’s up to the seller to bring relevant facts and address buyers’ concerns. This suspicion is not personal and should not be interpreted as an accusation of dishonesty.  Buyers are committing huge amounts of capital and their whole future relies on the success of the transaction.
4. Good preparation: It’s advisable that sellers prepare a large portion of the documentation needed for due diligence before putting the business up for sale, especially financial and accounting information, stock, legal documentation etc.
5. Patience: It takes a lot of patience to sell a business and due diligence is one of the final steps. At this stage, sellers are generally exhausted and are vulnerable to emotional bursts.  It’s important to control your mood.

While my description of the due diligence process might seem too general and lacks specifics about the types of documentation needed, my experience as a Business Broker in Toronto, Ontario has taught me that applying these principles is a key factor is to reaching a successful deal.

Honesty with business brokers: serious business sellers use the services of competent business brokers to sell their companies. Business brokers will use the information provided by the seller to present the business at its best lights to the right buyers who are most likely to present serious offers. What happens when sellers misrepresent or exaggerate their companies advantages to business brokers? The answer is very simple: the business is presented to the wrong buyers. Brokers put their best efforts to convince these buyers that the business presents a good opportunity for them.

When an interested buyer presents an offer that seller accepts, he/she start their due diligence only to discover that the business was misrepresented. The buyer loses confidence in the seller and in the broker and starts questioning all information provided to him/her. Worse, the buyer feels deceived and realize that they cannot work with the seller anymore. The obvious outcome is: the offer is withdrawn and the buyer gets back his/her deposit. This is a huge waste of time for the seller, the buyer and the broker. It’s a lose, lose, lose situation. Had the seller presented a more realistic picture of the business, the same buyer might still have been interested or another more suitable buyer might have been found. A lot of time and professional fees would have  been saved and the business would have been sold.

Honesty with buyers: when investigating a business to purchase, most buyers have a prepared list of questions and want to get answers directly from the seller. Most buyers understand that no business is perfect and expect the business to have some drawbacks. If the seller starts embellishing the business to the extent that it seems perfect, buyers automatically question the seller’s honesty. Trust is lost very quickly during the discussion and the business seems too good to be true. Of course the buyer loses interest and the seller loses the opportunity to sell the business to that buyer.

Honesty with employees: nobody suggests to tell employees about the possible sale of a business early when the business owner is contemplating selling his/her business. However,  at some point of the sale, key employees should be made aware. It is generally a very bad idea to lie the them about the subject for the simple reason that when they will know (and they will know) the will lose faith in the present owner and in the business. They will assume that the owner lied about many other matters and they will look for alternatives to their present job and/or revenge. The same employees could sabotage the deal by presenting a bleak picture of the business to the buyer and push him/her to walk away from the deal.

honesty is a virtue when doing business and almost always pays off. This is even more true when selling a business whether small or large.