Preparing to Sell a Business: What Documents are Needed for Diligence?

Although it’s difficult to know exactly how many, we can reasonably assume that a significant proportion of deals fall through because sellers fail to anticipate the requirements of the due diligence process. Having spoken to potential acquirers of their business, sellers will often be familiar with the questions which repeatedly arise and may feel that due diligence is just a formality. This is an error.

The seller should attach just as much importance to the due diligence process as the buyer. First, because the aim of any seller should be to make the process as easy for the buyer as possible — if you don’t, somebody else will. Second, because if negligence in due diligence can be proven, it can come back to haunt you in the form of litigation. Hence, sellers’ due diligence is not something that can be overlooked. Below, we provide a checklist of dos, don’ts, and the documents required, with the usual caveats about every process being slightly different.

Before beginning

Just as with buy-side due diligence, practitioners on the sell-side will save themselves a lot of time and effort by investing in a virtual data room (VDR). DealRoom is just one option here, but there are many. We outlined the benefits of acquiring a VDR in a previous article (insert link). On the sell-side of a transaction, many of the same benefits to having a VDR apply with at least one extra detail: When new buyers express interest in acquiring the business, owners can simply request an NDA from the buyer before providing them with direct access to the VDR and all of its documents.

Your sell-side due diligence checklist

If you’re not convinced that you’ll need a Virtual Data Room before the M&A process begins, the scope of the documents needed to sell a business will soon convince you. There can be dozens of documents, some which are relatively easy to retrieve (such as your latest financial statements) and others which will require some work, and will need to be updated reasonably regularly during the due diligence process (working capital reports on projects underway). These aren’t the kind of data that can, or indeed should, be shared by email.

It’s a good idea to consult with some senior people within your company (Directors of Finance, Legal, HR and Technology, for example) to get their feedback on the kind of information they can pull together which might help with the sale. They may even suggest weak points within their departments which can be dealt before buyers come knocking (Note: ‘dealt with’ does not mean ‘ hidden ‘ — it means resolved in a timely and transparent manner so that it will no longer be an issue that detracts from the business).

So, here are the documents needed to sell a business

Below, I address the issue of a checklist and documents required for each department in turn:

1. Legal

• Governing and constitutional documents of the company
• Details of the terms of current contracts with all stakeholders, internal and external
• Details of the company’s licences, permits and legal obligations
• Details of the company’s compliance requirements (e.g. does a certified professional have to occupy a senior management position as with engineering firms)
• Previous and ongoing litigation claims by or against the company
• Details of all patents and IP owned/leased by the company

2. Financial

• Up-to-date financial statements (preferably audited to most recent quarter)
• Substantial notes to accompany the financial statements and in-depth explanation of any deviations from GAAP or IFRS)
• Highlight ongoing working capital requirements
• Highlight future capital expenditure requirements (preferably with an in-depth overview of current depreciation of capital assets)
• Details of outstanding debt obligations
• Budget forecast (particularly cash budget)

3. Human Resources*

• Details of all staff, their positions and contract details, length of time with the company, including benefits
• Details of total outstanding pensions benefits obligations held by the firm
• Details of the company’s hiring policies and procedures
• A copy of the company’s latest employee manual
• Details of disputes/loans/ongoing discussions with employees
• Most recent resumes of all senior managers at the company

*If you’re happy to potentially expose details of your company to unauthorized third parties, email works fine — and as owner of the company, that’s your prerogative. But be under no illusion that a leak of your employee’s data is a serious data breach and needs to be treated in a secure and confidential manner.

4. Information Technology

• Details of your company’s technology stack
• Details of contracts with third-party suppliers (technology and maintenance contracts)
• Diagram of the company’s IT infrastructure
• Breakdown of total ongoing IT costs
• Detail of when each component of technology capital was acquired
• Details of mobile device security and outstanding company mobile devices

5. Other Items

• Detailed organizational chart
• Overview of the company’s tax affairs (including tax returns for at least 3 years and details of any outstanding tax obligations)
• Future unstated liabilities (for example, environmental liabilities)
• Details of any written contracts, verbal contracts, and ‘handshake agreements’ not outlined elsewhere in sellers due diligence

Conclusion

If the checklist for sell-side due diligence seems long, be aware: these are just the essentials. Buyers can request all kinds of details that you hadn’t anticipated. For example, one common request not listed above — but perhaps one to prepare for — is that the buyer will want to speak to at least one of your clients. It may be a good idea to anticipate this by mentioning it to some clients in advance of you selling the business — preferably ones you can trust.

As the extent of this information shows, there’s a lot in sell-side due diligence, both in terms of scale and privacy that has to be taken into account. It doesn’t send a good message to a buyer when you’re flippant about passing confidential details across to newly acquainted third parties. There’s a reason that all of the most successful M&A practitioners invest in VDRs for their due diligence process and we suggest that you do too.

Originally published at https://dealroom.net.