Due diligence is a cornerstone of any business sale and offers buyers the assurance that the transaction is based on realistic expectations and dependable information. Due diligence is especially relevant in smaller businesses, which are generally non-reporting entities free from requirements to adhere to AASB accounting standards, and where accounts are kept primarily for tax purposes, and often not regarded as management tools.

Due diligence can take anywhere from 6-12 weeks depending on the size and complexity of the business. Sellers should be prepared for several different types of due diligence when selling their business. These include financial, commercial, legal and environmental due diligence.

During the diligence period, the buyer will request and review various documents about the company and its operations, including historical financial statements, tax returns, bank statements, contracts, customer listings, supplier listings, financial ratios, and business trends. Gaining access to both customers’ and employees’ insights is vital for buyers but can be unnerving for sellers. Savvy buyers understand how to handle these sensitive situations with utmost discretion. Instead of relying on interviews with customers or employees, a buyer may be able to unlock valuable insights by engaging in a survey-style approach examining what makes customers and employees satisfied or unsatisfied.

Financial due diligence involves analysing historical financial statements to determine the true earnings, and stability of the business. The buyer will look at both gross and net margins, capital expenditures and owner’s compensation to see if they are consistent with industry peers. They’ll also take a closer look at an organization’s revenue recognition efforts, ensuring each reported amount is accurate and free of any potential timing issues or irregularities like unreported earnings or channel stuffing. The basis of valuation of material assets on the balance sheet, namely inventory, property, plant and equipment and ‘related’ assets (e.g. factory owned by family trust) is also considered. When looking at a business, the buyer will go beyond just what’s on the balance sheet. The diligence process takes into account potential liabilities and commitments that may arise in the future – from leases to capital commitments and contingent labilities – so the buyer can predict how these items could influence the business going forward.

Commercial due diligence on the other hand is concerned with future performance, market position and brand value. This may involve accessing trade publications, competitor websites and industry best practices and examining information about customers, and distribution channels. One factor that is often considered during valuation is whether there are any key employees with specific expertise relevant to future plans for the business. A buyer may wish to retain these individuals if they provide a competitive advantage.

Taking the plunge into due diligence is no small undertaking, requiring significant commitments of resources from both buyer and seller. However, the due diligence process doesn’t have to be a source of anxiety. With some preparation and insight, it can easily become an efficient journey towards the successful sale of your business.