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What is due diligence?

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WHAT IS DUE DILIGENCE?

Due diligence is the process taken by a buyer or a lending institution to evaluate and research a business in great detail. During this period, the buyer or lending institution is verifying the business financials, legal items, and other miscellaneous related items.

How long does the due diligence process take?

No two transactions are the same, so quoting a specific time period for the due diligence process is extremely hard. Most small to medium sized businesses will have a due diligence period that usually takes anywhere from 2-8 weeks. The length depends on a number of factors.

If a lending institution is involved, the process generally takes much longer. This is because there is usually two due diligence periods. The first period usually occurs upon execution of a Letter of Intent or Asset Purchase Agreement The prospective buyer will negotiate a period of time to research the business to ensure they want to move forward. This period is usually anywhere from 14-45 days depending on the business.

Once the buyers due diligence is complete, the buyer will move forward with their lending institution to begin the loan process. After the loan process starts, the lender will conduct their own due diligence to ensure the business is worth the price it is being purchased for and the loan can be repaid with some certainty.

Larger transactions tend to have longer due diligence periods. This is simply because there usually is a lot more to go through. For example, a business that does 2000 transactions a month has a lot more items to look over than a business that does 10 a month.

What to expect during the due diligence period?

Depending on your role in the business transaction, the due diligence period can be a blessing or a curse. For sellers, it is usually a very stressful time. You will have multiple people asking you many questions, wanting specific details, and lots of documentation. Their purpose is to either prove or disprove your business’s worth. Most of the time, it feels like the latter.

Buyers on the other hand, use this time to determine if the business is one they want to buy. Most buyers benefit from their lenders due diligence. This is because most buyers only buy one or two businesses in their lifetime. Banks on the other hand are trained to catch red flags and evaluate many companies a month. Their due diligence not only protects themselves, but helps protect the prospective buyer as well. Typically the banks due diligence is significantly more advanced than a prospective buyers which helps protect them from a bad purchase.

Some buyers tend to feel stressed out during this process as well. Especially when they are extremely excited about the business and want the entire process to be complete.

How to prepare for the due diligence process

A prospective buyer can take multiple approaches to the due diligence process. It really depends on the buyer themselves. Some buyers hire professional consultants to perform the process for them. Others do it on their own or wait for the lending institution to do it for them. Regardless, we strongly recommended the buyer to hire a professional consultant in addition to their own analysis.

For a seller, we recommend having “clean” books, being transparent, and prepared. This can be done by having all your documentation ready ahead of time. If there are any issues, having explanations prior to questions and disclosing any potential issues ahead of time.

Conclusion

Regardless how prepared you are as a seller, the due diligence process will always be stressful. It requires work to provide all documents needed and you will have people asking you questions you are probably not expecting. We always tell our selling clients ahead of time this is probably the hardest part of the sales process, even if your prepared.