Conducting “due diligence” is crucial when buying or selling a business and must be completed before entering into a purchase agreement and closing the deal. Buyers should know everything about the business to determine the purchase price and assess any current or potential liabilities. Sellers should be ready to produce all information and documents relating to the business, such as financials, employee information, client contracts, intellectual property information, marketing strategies, membership/shareholder information, etc.
What is due diligence?
During the due diligence process, the potential buyer of the business requests extensive documentation and information from the seller. They review this material to ensure the business is in good standing financially and legally, and to identify any issues that may impede the sale, such as liabilities.
The due diligence process varies depending on the type of transaction. For example, during an asset purchase (this means the buyer is buying a business’s assets, and sometimes the business itself), due diligence requests will focus on the assets being purchased (this can include equipment, client lists, materials, real estate, etc.). During a membership interest or stock purchase (this means the buyer will acquire only a percentage of the business’s ownership interest), due diligence will likely focus on the business’s valuation and finances. However, whether you are part of an asset purchase or an interest purchase, you will want to investigate all relevant aspects of the business for sale.
What information is exchanged during the due diligence process?
It depends on the buyer, since the buyer is the party making the request. Some buyers ask for all information regarding the business. Depending on the transaction, others may focus on specific areas within the business. In general, due diligence will focus on:
- Company structure (subsidiaries, members, shareholders, etc.)
- Client contracts
- Finances (tax returns, bank accounts, liabilities)
- Employee information
- Real estate and leases
- Intellectual property (patents, trademarks, etc.)
- Litigation history (past and current)
As a buyer, you should also do independent research about the business. Googling the business and the members/shareholders can produce helpful information. We also suggest you search the business and its members/shareholders in state and federal courts to find out about any pending litigation. Depending on the size of the business, you may also call the Illinois Department of Employment Security to check if there are any unemployment issues you would inherit with the business.
Because sensitive information will be exchanged, a strong Non-Disclosure Agreement will be necessary to maintain the integrity of the deal. Be sure you have one in place before beginning due diligence.
Buyer: What do I do with the information I receive?
Good question! You (or, ideally, your attorney) will receive a lot of documents and information from your due diligence requests. Keep careful track of the documents to make sure nothing gets lost or overlooked. We find it helpful to keep a checklist to record when the material was produced, who reviewed it, and any notes/concerns regarding the information.
Your attorney can review many of the documents (think leases, client contracts, employee agreements, manuals, and classifications, permits and zoning, etc.), for any oddities or significant details. You will also want to have an accountant or business valuation expert dissect the business’s finances.
Seller: How do I know my information will be kept confidential?
Make sure you have the potential buyer sign a strong NDA! In fact, this topic is so important we wrote an entire article about it. You will be giving the potential buyer extremely sensitive information about your company, and you will want to ensure it is safely guarded.
Due diligence is a daunting task to undertake on your own. We have helped many businesses through this process. Contact us today for a free consultation!