After an offer for your business has been made and accepted the next step is Due Diligence where the buyer will review the books and records of the business to verify the revenue, earnings and veracity of the business. Due Diligence is a Contingency for both Buyer and Seller; the buyer’s deposit check is not cashed and Escrow is not opened until after both buyer and seller have removed this contingency. When the Due Diligence Contingency is removed the Business Broker will send the Purchase Agreement documents and buyer’s deposit check to Escrow. Escrow will deposit the buyer’s earnest money deposit check into their trust account, draft the escrow documents, and once these documents are signed Escrow is opened.
During the Due Diligence process the role of your Business Broker is to organize and facilitate the process and most importantly keep it on track. The buyer and seller may engage other advisors (see below) to assist and advise them during the Due Diligence process.
Due Diligence typically takes 3 weeks for a small to midsize business and can take longer for larger or more complicated businesses; or if the records and business information is not readily available from the seller. At Pacific Business Sales we use the CABB (California Association of Business Brokers) Purchase Agreements for both business Asset Sale and Stock Sale transactions. The CABB agreement breaks Due Diligence down into three steps shown below with the number of calendar days specified for each step. The number of days is specified by the buyer when the offer is prepared with the Business Broker.
At the conclusion of the Due Diligence period each party removes the Due Diligence Contingency and the broker will open escrow. Should either party decide not to remove the Due Diligence Contingency the transaction is terminated and the buyer’s deposit is returned in full (see Wrapping Up Due Diligence below).
Below is a typical Due Diligence list for a small to midsize business. Note that different businesses and industries will have additional items specific to that business or industry and the buyer’s CPA or financial advisor may have additional items they wish to review. If the transaction is a Stock Sale, there will be additional items relating to corporate records that require review.
In many transactions the buyer and seller opt to conduct the Due Diligence review on their own. This is typical for small transactions where the financial statements and other records are straightforward. Some buyers may engage a CPA to assist them with the financial review and if the transaction is a Stock Sale the buyer may also engage an attorney to review the corporate records. Likewise, some sellers may need to engage their CPA or accountant to provide the requested financial information to the buyer and answer questions about the P&L, Balance Sheet, expenses, tax returns, and owner benefits/expense add backs.
The Business Broker representing the seller and/or buyer if they are a dual agent cannot act as an advisor to either party with respect to Due Diligence as they are not a CPA or accountant and cannot provide financial or legal advice to either party. The broker can facilitate the Due Diligence process and assist buyer and seller in organizing the process and answer questions relating to the transaction.
Much of the focus of Due Diligence is on the buyer side, but there is also a seller Due Diligence contingency. During the Due Diligence period the seller has the opportunity to review the buyer’s qualifications, financial wherewithal to complete the transaction and ability to run the business. Typical seller Due Diligence items are:
At the end of the Due Diligence period the Business Broker will send buyer and seller a Due Diligence Contingency Removal and Authorization to Open Escrow document for signature. When the Contingency Removal is signed the broker will send the purchase agreement documents and buyer deposit check to escrow to draft Escrow docs, obtain signatures and open Escrow.
If the parties require more time both can agree, and the broker will write an addendum to the Purchase Agreement extending the Due Diligence period.
If the buyer has found problems during Due Diligence the first step is to review the issues with the seller. Often the perceived issues are either a misunderstanding of the financial statements, a result of missing information, or a minor issue that is resolved after review with the seller.
If the issue is significant there are three options 1) negotiate an accommodation with the seller which may involve price or terms, 2) accept the agreement as is if the issue is not significant, 3) terminate the agreement in which case the buyer’s deposit check is returned in full and the transaction is cancelled.
Due Diligence is perhaps one of the most important steps in purchasing a business, second only to the actual purchase agreement and negotiation. With the help of a professional Business Broker to prepare and negotiate the offer and facilitate the process you can look forward to a timely and successful transaction.