Having navigated through due diligence a few times while selling my own companies, I’ve learned first-hand that knowledge of the process can significantly smooth the path for both sides.
Having gone from operator to investor, I feel well placed to bridge the gap between the business bit and the finance bit. This article is here to give you a clear outline of what to expect when you enter into an agreement to sell your company.
At Milfort, we buy businesses from retiring owners and we want to make the selling process as easy as possible. We recognise that selling a company is usually a once in a lifetime endeavour and that much of the legal terminology and corporate finance jargon that comes as part of the due diligence process is alien to most owners.
As a seller, if you understand the process from start to finish, I guarantee you will have a more efficient and positive experience selling your company.
First things first, what is due diligence?
Due Diligence is a process which should be started years, not months in advance of a sale. So it’s never too early to get started.
It’s a research process which helps the buyer get to know and understand your business in a condensed timeframe.
You, as the owner have lived and breathed the company for decades. The aim is to get the information out of your head and on to paper so key aspects of the business can be documented and formalised in a Share Purchase Agreement which will effect the sale of your company.
Why can diligence be difficult?
It can be a time of high stress. You company is on the market and people are interested. You can already see the finish line and you are eager to cross it. This can lead to feelings of impatience and frustration because many of the questions (and there are many many questions), can seem irrelevant or outright blunt.
You know the business is great. Why can’t the buyer see it as well?
Going through the process myself for the first time, I felt many of the questions that diligence posed were accusatory or designed to catch me out. But looking at it dispassionately, its simply a process designed to give the buyer clarity on the whole of your business.
The fact is, no business is perfect. They are all messy. Especially at the lower end of the market (sub £5 million profits). The buyer just wants to understand the business “warts and all” so they understand how to structure the purchase agreement, uncover areas for improvement and set the stage for a mutually beneficial partnership.
Once the deal is concluded, you will likely still be involved with the business in some capacity for a period of time to ensure a smooth handover. You want the relationship to have a solid foundation.
Below are the 9 main areas a buyer will seek to understand:
1. Company Identity and Organisation
Legal Structure and Incorporation Details
This section clarifies your business type, like a private limited company or partnership in the UK. It affects legal obligations and taxes. You’ll need details like your company registration number and registered office.
Ownership and Shareholder Agreements
Explains who owns your business and their shares. It’s vital for outlining each owner’s rights, profit shares, and decision-making processes. Shareholder agreements or a list of owners will be requested.
Organisational Chart and Key Management
This part maps out your business’s structure, showing who manages what. It helps understand reporting lines and key personnel roles. Prepare an organisational chart including names and positions of top management.
Historical Development and Background
Provides a backstory of your company, including major milestones and growth phases. It gives context to your current position and future potential. Documents like a company history summary or founding documents may be needed.
2. Financial Analysis
Audited Financial Statements and Accounting Policies
This section reviews your business’s financial health through formal records like balance sheets and income statements. It includes how you recognise revenue and expenses, crucial for understanding financial stability.
Revenue Analysis and Profit Margins
Focuses on how your business earns money and keeps it after expenses. It’s about identifying main income sources and how efficiently you convert sales into profits.
Cash Flow Analysis and Investment Activities
Looks at how cash moves in and out of your business, highlighting your ability to cover expenses, reinvest, and manage debts. It’s a snapshot of financial health beyond profits.
Financial Projections and Assumptions
Involves your forecasts for future earnings, spending, and growth, based on current data and market trends. It shows your business’s potential and planning accuracy.
Debt Structure and Financing Agreements
Details your company’s debts, loan terms, and repayment strategies. It assesses financial risk and your ability to manage and finance growth sustainably.
3. Assets and Liabilities
Inventory and Physical Asset Verification
Checks the value and condition of physical goods and property your business owns, ensuring records match actual assets, important for valuing your company.
Intangible Assets and Intellectual Property
Evaluates non-physical assets like patents, trademarks, and copyrights, vital for understanding your business’s unique advantages and legal protections.
Current and Long-term Liabilities
Examines debts and obligations due within a year and those due later. It’s key to assessing your company’s financial commitments and stability.
Contingent Liabilities and Potential Exposures
Identifies possible future liabilities based on outcomes of uncertain events, such as lawsuits or warranties, critical for understanding hidden risks.
4. Operations and Business Model
Core Business Processes and Efficiency
Evaluates how your business functions day-to-day and its operational efficiency, focusing on activities that generate value.
Supply Chain Management and Logistics
Assesses how you manage the flow of goods from suppliers to customers, crucial for timely delivery and cost control.
Customer and Market Analysis
Involves understanding your target audience and market dynamics, essential for strategic positioning.
Revenue Streams and Business Strategy
Reviews how your business makes money and its long-term plans for growth and competitiveness.
5. Human Resources and Employment
Employee Structure and Distribution
Looks at how your workforce is organised and where they are based, important for operational effectiveness.
Compensation, Benefits, and Incentive Programs
Examines how you reward and motivate employees, key for retention and satisfaction.
Employment Contracts and Labour Law Compliance
Ensures your employment practices adhere to UK laws, critical for legal and ethical operations.
6. Legal and Compliance
Compliance with Local and International Laws
Checks adherence to laws affecting your business, vital for legal operation.
Intellectual Property Rights and Legal Disputes
Reviews protections and disputes over creative and innovative works, significant for safeguarding assets.
Environmental Regulations and Compliance
Assesses adherence to environmental laws, crucial for sustainable operation.
Data Protection and Privacy Laws
Ensures compliance with laws protecting personal data, essential for trust and legal operation.
7. Market and Industry Position
Competitive Landscape and Market Share
Analyses your position among competitors and your market presence, key for strategic planning.
Industry Trends and Technological Advancements
Looks at how industry changes and tech developments affect your business, important for innovation.
Customer and Supplier Dependencies
Reviews reliance on specific customers or suppliers, crucial for risk management.
8. Technology and Intellectual Property
IT Systems and Software Use
Examines technology infrastructure, vital for efficiency and security.
Intellectual Property Portfolio
Reviews owned patents, trademarks, essential for competitive advantage.
Research and Development Activities
Assesses investment in innovation, crucial for future growth.
9. Environmental, Social, and Governance (ESG) Factors
Environmental Impact and Sustainability Practices
Evaluates environmental footprint and sustainability efforts, key for responsible operation.
Social Responsibility Initiatives
Looks at contributions to social issues, important for reputation.
Governance Structure and Ethical Standards
Reviews governance practices and ethical conduct, crucial for trust and compliance.
