Why Vendor Due Diligence Matters
You’ve spent years building your business. For many owners, the decision to sell represents more than a change in ownership, it can be one of the largest releases of equity they will experience.
When the time comes to sell, buyers will want to understand exactly what they are acquiring. That means scrutinising the financial performance, contracts, people, assets and potential risks within the business.
But preparing for that scrutiny shouldn’t start when you receive an offer.
Vendor due diligence gives you the opportunity to get your business in order before you go to market. This will help you identify and address potential issues while you still have time to do something about them.
What is vendor due diligence?
Once you receive a letter of intent or heads of agreement, a buyer will typically make the transaction conditional on satisfactory completion of due diligence within an agreed timeframe.
Due diligence involves providing the buyer and their advisers, usually their accountant and lawyer, with information about the business. This information is often uploaded to a secure online “data room”, which becomes the central repository for documents throughout the transaction.
The purpose is to validate the information provided, understand the financial strengths and weaknesses of the business, and identify potential risks.
For a seller, this process can be time-consuming. Responding to information requests can divert you and your team away from running the business. More importantly, delays or gaps in the information provided can create uncertainty and friction with a prospective buyer.
That’s why preparation matters.
Think of your business like a property
When preparing a property for sale, most vendors understand the value of presentation. You might repaint the walls, replace worn carpet, tidy the garden and make sure the property presents at its best.
Business owners don’t always take the same approach when preparing their business for sale.
Vendor due diligence is essentially about getting your house in order before the buyer arrives.
Ideally, this preparation should begin well before you list the business. It gives you time to identify issues, resolve inconsistencies and make sure the information supporting your business is accurate, complete and readily available.
Where should you focus?
- Business documents
Start by bringing together the key company, financial and legal documents relating to the business.
Make sure contracts and agreements have been properly signed and that any amendments or superseded agreements are documented and retained.
Pay particular attention to customer and supplier arrangements that may have been operating under a “mutual understanding” rather than a formal contract. While these arrangements may feel straightforward to you, they can represent a risk to a prospective buyer.
It is also worth reviewing your insurance arrangements to ensure your cover remains appropriate. Gaps in insurance can become a point of negotiation during a transaction.
The earlier you identify these issues, the more time you have to address them.
- Financial records
Financial due diligence will start with the quality of the information supporting your business’s financial performance.
Your accounting system reports should reconcile with your signed financial statements and tax returns. It is also worthwhile talking to your accountant about how your financial statements and tax returns have been prepared, including any adjustments that have been made.
Your balance sheet deserves particular attention.
Are there old debts that should be written off? Is there obsolete stock that should be removed? Are there other items that no longer accurately reflect the position of the business?
Cleaning these up before a sale can provide greater confidence in your financial position and demonstrate to a prospective buyer that the business is being actively and proactively managed.
- Staff records
Your people and employment arrangements will also come under scrutiny.
Make sure employment agreements and any subsequent amendments have been properly documented and signed.
If you are selling the shares in your business, employee entitlements (including annual leave) may be an area of focus for the buyer. If you have employees working variable hours, an independent review of your leave calculations can help identify potential issues before they become a problem during the transaction.
The advantage of starting early
The biggest advantage of vendor due diligence is simple: time.
Once a prospective buyer is conducting financial due diligence, you no longer have the luxury of dealing with issues at your own pace. Information requests are coming in, deadlines are approaching and the buyer is forming a view of the business based on what they find.
Starting earlier gives you more control.
And importantly, you don’t need to have a sale around the corner to benefit from the process. Getting your financial records, contracts, employment documentation and business information in order is simply good business practice.
For owners who are beginning to think about their next chapter, it can also be an important part of a broader exit strategy.
Thinking about your next chapter?
Selling a business is rarely a decision that happens overnight. For many business owners, particularly those who have spent decades building their wealth through their business and property investments, the conversation about an eventual exit starts years before a sale.
Whether you are actively considering a sale, thinking about succession, or simply want to understand what your business could be worth and what needs to happen to prepare it for the future, it is worth starting the conversation early.
The right preparation can give you greater control over the process and help ensure your business is in the strongest possible position when the time comes to make a move.
If you’re thinking about your business exit strategy, or want to understand how vendor due diligence could help prepare your business for sale, talk to me or the PKF Withers Tsang team. We can help you identify what needs attention now, so you’re better prepared when the time comes.