In a business sale, due diligence is when the buyer checks that the figures presented hold up. Many negotiations crack at exactly this point: often not because of a serious problem, but because of a problem discovered late and poorly explained.
What due diligence is
It is an in-depth review of the business before signing. It can cover financial, tax, legal and employment matters and, in some sectors, technical and environmental ones. Here I focus on financial due diligence, which usually drives the price.
What financial due diligence looks at
- Quality of earnings: how much of EBITDA is recurring and how much depends on one-off items.
- Working capital: receivables, inventory and trade payables, compared with a normal level for the business.
- Net financial debt and debt-like items, such as overdue tax and social security liabilities or litigation.
- Quality of revenue: customer concentration, existing contracts, recurrence.
- Off-balance-sheet commitments: guarantees given, leases, contractual commitments.
How findings turn into price
The issues found do not stay in the report. They translate into a price reduction, adjustment mechanisms based on the accounts at the closing date, warranties and indemnities in the contract, or part of the price held back as security.
Vendor due diligence
The seller can have their own figures reviewed before going to market. The benefits are tangible: shorter timescales, fewer surprises in the negotiation and the chance to explain issues before the buyer finds them.
How to prepare
- Financial statements and interim accounts reconciled with the books.
- An organised data room, with the key documents easy to find.
- A written explanation of variances and one-off items.
- Tax and social security position up to date or documented.
Above all, the buyer wants to know whether the numbers can be trusted. Preparing in advance is the most effective way to defend the price.
Further reading
Can I help you with this?
If you are thinking of selling, the first step is to understand what a buyer would find in your numbers.
