If you’re a business owner looking to sell your business in the near future, you may be discouraged to hear that many sale transactions fall apart during the due diligence phase. You can reduce this risk by focusing on records management now and getting your company’s business records in order well before you put your business on the market. 

Think of it like getting your personal house in tip-top shape before you list it for sale. Makes sense, right?

What is Due Diligence?

Just as the inspection process is a critically important part of buying and selling a house, due diligence may be the most critical phase in the early stages of buying or selling a business.

During the due diligence process, the potential buyer will want to learn the intimate details of your business — its strengths, weaknesses, opportunities for growth, and areas of concern. The buyer’s objective is to uncover as much as possible about the business before buying it to justify the purchase price and avoid unwelcome surprises after the deal closes. 

In all our years working with clients on due diligence on both sides of the transaction, we never saw a selling business that was in perfect condition. While perfection in running a business is an admirable goal for a business owner to have, it isn’t realistic. No matter how hard a business owner tries to have everything perfectly in order, we can almost guarantee a potential buyer will discover at least one gap or issue during the due diligence investigation. 

Getting the Business House in Order

One way a business owner can get a feel for issues a buyer might raise during due diligence is to go through a “pre-sale due diligence” exercise on his or her own business before putting it on the market. It’s like conducting an inspection of your home before listing it, so you have a heads up about repairs a buyer might require before closing or demand a price reduction for, or any items like a faulty foundation that may be so significant that the buyer might decide to walk away altogether. We think most sellers would agree that, when it comes to selling what is arguably their most valuable asset, they’d like to minimize unpleasant surprises and the added stress that comes with them.

The scope of a buyer’s due diligence will vary based on the nature of the business and the transaction, and one buyer will have different requirements from another. But business owners can start their pre-sale due diligence and records management assessment by gathering information based on a general due diligence checklist from a trusted advisor. 

Pre-sale due diligence and prudent records management require a relatively deep dive into legal, financial, accounting, tax, operational, administrative, and other business matters. A robust assessment includes a detailed review of many business documents and information in a variety of categories. Examples include the following: 

• Corporate records for the corporation or LLC that document formation and ownership, approval of non-routine business transactions, and business qualifications 
• Material contracts with top customers, suppliers and consultants
• Personnel records, benefit plans and compensation arrangements
• Intellectual property ownership and licensing arrangements
• Property, plant and equipment information
• Information on pending or threatened litigation, disputes, and regulatory proceedings or investigations
• Environmental, health and safety records
• Compliance policies, training materials, and certifications
• Financial statements and projections, budgets, and tax returns
• Loan documents
• Business plans, sales and marketing materials 
• Insurance policies and claims history

The Time Is Now

Collecting documents for the assessment will take time and odds are that some documents will come up missing. That’s why we recommend starting the assessment sooner rather than later. Generally speaking, it’s a good idea to begin one to three years before putting your business on the market.

If you’re unsure how prepared you are and the lead time you’ll need to get organized, take the general due diligence checklist I mentioned earlier and grade your readiness in each of the categories. An “A” means you know exactly where the documents are and could provide them immediately if you had to, and a “C” means you’re not sure where the documents are and you’ll need to set aside extra time to find them. 

Most business owners we’ve worked with over the years would receive an average grade, which is no surprise when you consider everything business owners have on their plates when it comes to running their businesses. It’s nothing for a business owner to be ashamed of, but it should be a realization of the opportunities ahead to get your business records in order.

Lean on Experts

This exercise in pre-sale due diligence and records management may seem overwhelming, especially for a business owner who is trying to run the business and may have little or no experience or time when it comes to participating a pre-sale due diligence or records management assessment. But professional advisors like business administration experts can provide much-needed assistance at a reasonable cost.

A business administration expert experienced in due diligence can lead the effort for the business and play an active role in collaborating with the business owner and key employees; in compiling, reviewing, and organizing documents and information; and in identifying areas where legal or other professional expertise may be needed to fully understand and address issues or gaps in your business records.

Also, a business administration expert can play a lead role in creating a central archive of critical business documents and information, identifying key members of the selling business owner’s due diligence team, and developing a process for facilitating due diligence when deal opportunities come along in the future.

ROI and Peace of Mind

A careful review of the business well ahead of an anticipated sale will enable the due diligence team to identify and resolve issues before a potential buyer uncovers them. 

There may be issues that can’t be resolved. For these, the pre-sale due diligence assessment gives the selling business owner an opportunity to fully consider and prepare responses or proposed resolutions to issues a potential buyer may raise during deal due diligence. Without this forethought and planning, sellers risk being surprised by an issue a potential buyer raises and appearing tentative, disorganized or as if they have something to hide if they can’t provide candid or timely responses.

Issues that arise during deal due diligence can cause delays in closing, reduce the price a buyer is willing to pay, or even kill the deal. So, the reality is that a selling business owner simply can’t afford to be addressing avoidable document or information gaps when trying to instill value and confidence in themselves and the businesses they’re trying to sell. 

Tackling this business administration housekeeping ahead of time should put you as a selling business owner in a more favorable negotiating position with your potential buyer and increase the likelihood of a successful sale at the highest possible price. Plus, having your important business documents organized in one place should give you peace of mind and confidence while you continue operating your business day-to-day until you’re ready to sell or engage in fund-raising efforts with investors or lenders that will also be conducting due diligence on the business in their transactions with the company. 

Archive in a Virtual Data Room

For decades, large transactions began with sellers populating a physical room with mounds of paper documents in preparation for the due diligence phase of a sale transaction. Sellers then gave physical and tightly controlled access to prospective buyers. Today, the use of electronic, or virtual, data rooms is the standard practice in business transactions involving due diligence.

A modern-day virtual data room provides an organized, secure, cloud-based document repository that can be remotely accessed at any time by users who have permission. It is one of the many tools available to business owners and their professional advisors in sale, fund-raising, and loan transactions. A virtual data room also serves as a useful records management tool for businesses that aren’t preparing for a transaction any time soon because it provides an accessible, secure and affordable way to archive critical business information needed for routine operations.

Build a virtual data room over time, ideally starting as soon as the business opens. Start with the company’s formation documents and minute book contents. Upload documents as they are created, using electronic file folders to organize them based on the pre-sale due diligence checklist you’ve been using.

Once the virtual data room is built and updated, it will almost be as easy as flipping a switch to open it up to members of a prospective buyer’s due diligence team. A buyer who receives prompt access to current due diligence materials is more likely to view the business owner as competent, professional and credible at the outset.

On the other hand, a disorganized, poorly structured, outdated or sparsely populated data room will be a source of frustration for everyone. It will shatter confidence and could negatively impact the perceived value of the business or, worse, prove fatal to the deal.

In Closing

Preparing a business for sale and continuously managing business records involves processes a business owner should develop and implement early on and regularly update. It doesn’t take much for a business owner to get overwhelmed with records management if business documents and information aren’t organized in a centralized archive for easy access right from the start. But you don’t have to go it alone. Seek the help of external resources now so you can sleep better at night knowing your business records are in order and you’re in a position to get top dollar for your business when the time comes. 

You can’t afford not to.

Sheryl Nelson is president of On Point Business Administration. Sheryl’s experience as a business and M&A lawyer provides a unique perspective to clients retaining On Point as outsourced chief administrative officer. That insight also benefits exiting business owners who need to get their businesses in order before going to market and responding to thorough due diligence requests from potential buyers.