Preparing for Due Diligence Before You Go to Market

Preparing for due diligence means assembling the documents a buyer will request, reconciling your own numbers, and deciding how to present known issues before the business is listed. Sellers who do this work early protect their price, shorten the time to closing, and reduce the risk of a buyer renegotiating late in the process. Due diligence is where many deals lose value, usually because something unexpected surfaces and resets the conversation.

What due diligence is

Due diligence is the buyer's investigation of the business after an offer or letter of intent is accepted. The buyer and their advisors review financial records, contracts, operations, legal matters, and anything else that affects value or risk. It is typically a contingency in the purchase agreement, so the buyer can withdraw if the findings are unsatisfactory. See What Is a Contingency in a Business Sale?.

Build the file before you need it

Assemble these records and keep them in one secure location, physical or digital:

Financial

• Three to five years of financial statements and business tax returns
• Year-to-date financial statements
• Accounts receivable and payable schedules
• A documented list of add-backs with supporting records
• Loan documents and debt schedules

Legal and contracts

• Entity formation documents and ownership records
• The lease and all amendments
• Customer, vendor, and supplier contracts
• Equipment leases
• Franchise agreement, if applicable
• Licenses and permits
• Records of any past or pending litigation or claims

Operations and people

• Equipment and fixture lists
• Employee roster, roles, pay, and benefit summaries
• Employment and independent contractor agreements
• Organization chart
• Intellectual property registrations

Having this ready shortens diligence and signals to the buyer that the business is well run. It also helps protect confidentiality, because a shorter process gives word of the sale less time to spread. See Keeping a Business Sale Confidential.

Reconcile your own numbers first

Financial statements and tax returns should tell a consistent story. Where they differ, know why, and be able to explain it in a sentence or two. Buyers accept explanations offered upfront far more readily than explanations produced under pressure. The same applies to add-backs. Each one should be supported by documentation. See What Buyers Actually Look At in Your Financials.

Address known issues before a buyer finds them

Most businesses have a few soft spots:

• A handshake arrangement with a key vendor
• A lease near expiration or without assignment rights
• A customer that accounts for a large share of revenue
• An employee in a key role without a written agreement
• An unresolved dispute or compliance question

Not every issue can be fixed before a sale. Each one should be identified, and the seller should decide in advance how to present it. Some can be resolved. Others can be disclosed early and addressed through deal terms.

Consider a pre-sale review

Some sellers ask their CPA to review the financials the way a buyer's accountant would, or have an attorney review key contracts and the lease. A pre-sale review usually costs far less than a price reduction negotiated in the middle of diligence.

Why preparation pays

A buyer who finds nothing unexpected has little basis to renegotiate. Preparation keeps momentum on the seller's side, supports the agreed price, and moves the deal to closing faster. For the earlier checklist of what to gather before listing, see Are You Ready to Sell Your Business?.

If you are preparing to sell a business in Southern California, a confidential valuation from BusinessQuest Brokers is a practical first step. Request a valuation.

Frequently asked questions

How far back do buyers look during due diligence?

Buyers commonly review three to five years of financial records, along with current contracts, leases, and legal matters.

How long does due diligence take?

It depends on the size and complexity of the business and how prepared the seller is. Organized records can shorten the process considerably.

Should I disclose problems before the buyer asks?

Yes. Issues disclosed early with a clear explanation are far less damaging than issues a buyer discovers on their own.