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.

• Uncertainty about the asking price: small and medium size businesses do not command high price multiples. The selling price should not be the main motivation for selling a company. I frequently see frustration in seller’s faces when I tell them about what asking price they might ask for their business. Sellers say ” if I have to sell my business at this price then I would be better-off waiting another 2 years and earn this money in my business without having to sell it”. My answer is then “yes, wait 2 years and come to see me when you are ready to sell”. The business is worth more to its owner that it is to most potential buyers. Owners sell their businesses for other reasons than money. Reasons include need for change, retirement, new opportunities, sickness, moving, and many other reasons not related to money. However, for larger businesses ($1M and more in value) a deal structured as a share sale involves a tax advantage that makes the sale worthwhile financially.
• Uncertainty about Timing the sale: Most sales of small and middle market companies are driven by personal considerations that in most cases could be delayed. For example a seller contemplating retirement at the age of 60 could wait few more years before effectively retiring. This creates a huge indecision for business sellers. Timing the sale of a small or medium size business is mostly dictated by personal consideration rather economic cycles.
• Uncertainty about how to go about selling: this can be so overwhelming that the business owner keeps procrastinating for a long period before taking the necessary actions. For most sellers, this is a one lifetime event. As a result, sellers lack the  knowledge and experience to go through a smooth sale process. Some sellers discuss the issue with friends and relatives who are not qualified to advise them about it.  Other sellers would seek advice from their accountants or even entrust them with the sale of the business. Accountants however are qualified to do accounting but not to sell businesses. They are capable of analyzing the company financial statements but they are not qualified in marketing the business. Marketing a company for sale is a full time profession called business brokerage and requires a long experience and a variety of other skills including finance, sales, psychology, business strategy, marketing and others.

In my experience, business owners who know why they are selling and have a clear idea about what they will be doing after the sale and who seek help from professional brokers specialised in selling businesses are more successful in selling their companies.