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The term ‘due diligence’ refers to the process through which a buyer will review the information provided by the seller. In many ways, it is essentially a comprehensive and rigorous type of research, which occurs as part of the acquisition process before you finalise the deal. Due diligence in a business sale is highly valuable to the buyer because it gives them an insight into how the business is performing.
As the seller of a business, you must participate in the due diligence process. This article will detail what due diligence might look like if you are selling your business and then offer guidance on preparing for the due diligence process.
What Does Due Diligence Look Like?
While due diligence is one process, there are two types of due diligence: legal and commercial.
Legal Due Diligence
Legal due diligence will involve inquiries into the legal aspects of your business.
If the sale is a share sale, the buyer will want to know the company’s constitution. The company’s constitution refers to the company’s internal governing document and will include how share capital has been issued to shareholders. Similarly, a prospective buyer will want to know any disputes or litigation your company is part of. This is important as it will inform the buyer of potential legal risks in acquiring your business. It will also influence the purchase price of your business.
Financial Due Diligence
Financial due diligence refers to the process of checking numbers and making sure there are no hidden financial issues. This might happen through the buyer’s legal team or accountants getting in touch about your business’s financial statements. Financial statements can outline valuable financial information, such as checking tax history. This might also link with legal due diligence because it may identify potential issues that can be disputed with HM Revenue and Customs (HMRC).
How to Prepare for Due Diligence
Firstly, you should prepare for the buyer to want to review all material records of your business. Generally, this will include financial statements, sales records, employment contracts, equipment hire contracts, and records of your assets and liabilities. Therefore, it is good to have these documents ready to transfer to the potential buyer.
Often, however, some of the material records will be sensitive information. If you identify some documents as including sensitive information, you should enter into a non-disclosure agreement (NDA) with the potential buyer. A non-disclosure agreement is an agreement that restricts what the other party can do with the information that you give them. For example, a non-disclosure agreement may include clauses that specify what will happen if the:
- deal falls through, and the buyer has to return all of the confidential information you gave to them; and
- buyer breaches their confidentiality obligations.
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The Due Diligence Process
Once you sign a non-disclosure agreement, the next step is to convey the relevant information to the potential buyer. A common way of doing this is by using a ‘data room’. A data room is an online cloud-based document sharing system, making it easy for you to store documents and convey information to both the buyer and their legal team.
If the buyer has additional questions, they may submit an RFI (request for information), which will require you to submit a set of responses to the buyer’s questions.
After the Due Diligence Process
The due diligence process is an early part of the transaction. After due diligence is complete, you will want to prepare the sale agreement. Once you both agree to the terms of the sale agreement and the buyer has signed, the buyer will usually have a period of time to prepare to become the new business owner.
Key Takeaways
Due diligence is an integral part of the sale of a business, and you should prepare for it accordingly. The primary way of doing so is to ensure that your legal and financial documents are ready to be handed over to the potential buyer. When doing so, it will be wise to have the buyer sign a non-disclosure agreement, which will help protect confidential information in your business.
If you need help with your due diligence obligations in a business sale, our experienced business and purchase lawyers can assist as part of our LegalVision membership. For a low monthly fee, you will have unlimited access to lawyers to answer your questions and draft and review your documents. Call us today on 0808 196 8584 or visit our membership page.
Frequently Asked Questions
This will depend on the size of your business. Usually, a letter of intent (LOI) is sent to the seller explaining the buyers intent to buy the business. The letter of intent will often include a due diligence clause, which will outline some terms of the due diligence process, including but not limited to how long it will take, which parties are involved, and the expected conduct and rights of each party.
The due diligence process involves legal due diligence (inquiries into the legal aspects of your business) and financial due diligence (checking financial statements and other documents to ensure there are no financial issues).
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