The importance of Due Diligence in Selling Your Business

Whether you’re selling shares or assets as part of a business sale, the due diligence process is key. Having your affairs in order before committing to a sale by preparing for the due diligence process is vital for a smooth completion.

Solicitor Jack Peart and Trainee Solicitor Yasin Ahmed, of the Corporate and Commercial department, look at the importance of this process. Here is how you can prepare prior to any sale.

What is due diligence?

Due diligence involves reviewing documents supplied by the seller to the buyer. It’s an opportunity for the buyer, management teams, accountants, and their solicitors to examine and investigate the target business. Once a sale has been agreed, any buyer will be keen to begin the due diligence process as soon as possible. Being on the front foot as a seller will help stop this process from becoming fraught.

There are generally two types of due diligence.

Legal due diligence is what we, as solicitors, will primarily focus on. This consists of the buyer’s solicitors sending an information request, usually completed by way of a due diligence questionnaire. This brings to the buyer’s attention any issues, risks and liabilities involved with the proposed transaction. If the buyer does have any concerns, they can ask further enquiries or request warranties or indemnities within any sale documents to provide some protection should issues arise in the future.

The second type is financial due diligence. This is usually completed by the buyer’s accountants, who will raise enquiries in respect of lending, accounts and tax. Accordingly, it is crucial that the accountants or financial advisors are instructed well in advance of any financial enquiries. All financial matters relating to the business will need to be up to date to avoid any unnecessary delays.

What documents are disclosed?

There are various documents that may be disclosed as part of the process. This includes trading and supplier contracts, employee contracts, property documents and financial records. Where the seller is selling their company, this also includes corporate documents. This could include articles of association, statutory books, and records like board minutes and resolutions.

There are also documents available in the public domain to the buyer, such as those available at Companies House, which is why it is important to keep accounts, confirmation statements and all necessary filings up to date.

How are documents shared?

The documents provided as part of the process may be made available by a ‘Live Data Room’. Historically, a data room was a physical space filled with documentation relating to the target business being acquired. This involved a lot of copying and redacting to form a bundle at the end of the process that both sides could rely on.

The more commonly used method now is through an online version of the above. This paperless solution means more sensitive documents can be encrypted with 24-hour access, meaning that it is easier to update and upload. Virtual data rooms are designed for storage and sharing documents and can be more practical for sharing information with Coodes having its own data room facility to govern this process easily for buyers, sellers, and their advisers.

What can I do to prepare for the process?

It’s sensible to prepare for the due diligence well in advance of the transaction. Some easy wins are:

• Checking that the accounts and financial statements are up to date.
• Having ready the details of any trading, financial and supplier agreements.
• Holding clear and up to date details of your company or business structure and to ensure that this matches the records at Companies House.
• Ensuring your internal information is up to date and available, including employment contacts, polices, and health and safety records.

This will make the sale much easier for all parties involved. It could also potentially save time and costs at the point solicitors and accountants are instructed.

This is also a great opportunity to resolve any potential problems or concerns that prospective buyers may raise during the due diligence review. As a seller, you should not be concerned if issues arise. It’s uncommon to find a business where no issues arise during the due diligence process. It’s better to be open and honest with the buyer at this stage, rather than try and hide these issues and hope the buyer doesn’t become aware.

You could potentially avoid granting unnecessary warranties and indemnities if you can settle any potential issues at an early stage. This process forms part of the negotiation process in selling your business and may result in the buyer seeking a change to the structure of the deal or a price adjustment.

What are warranties and indemnities?

Once the buyer has conducted a review of the due diligence provided, they will normally look to the seller to provide warranties and indemnities about the documents disclosed, or information received, set out within the sale contract.

Warranties are contractual statements of fact provided by the seller which the buyer can seek to rely on. The buyer will request warranties for matters that have come to light in the process so that if it results in a loss to the buyer, they could make a claim against the seller for the loss suffered. That is why it’s better to highlight any issues upfront instead of having to worry about potential issues arising through non-disclosure later on.

Indemnities are slightly different from warranties, as these relate to a promise to pay or reimburse for a specific liability that may arise from the transaction, putting the buyer in the position it would have been had the loss not occurred. They generally arise from the due diligence process highlighting specific issues to which the buyer is reluctant to take responsibility for.

For more information about selling a business, you can also read Jack Peart’s blog on getting your affairs in order.

If you are in the process of selling your business, or are considering doing so, please do not hesitate to contact us using the online enquiry form. Alternatively, please call us 0800 328 3282.