Selling your business is one of the most significant milestones in an entrepreneur’s journey. However, even the most attractive businesses can falter during due diligence if they are not properly prepared. This stage is where buyers scrutinize every aspect of your business to evaluate risks, verify claims, and confirm the value they’re willing to pay.

In this article, we’ll explore what due diligence entails, break down the critical areas buyers examine, and provide actionable steps to prepare your business for a smooth and successful process.

Inspired by the principles shared in a session led by Tom Stoten of Cavendish Corporate Finance during the 2024 cohort of the Cyber Runway: Scale programme provided by the Department for Science, Innovation & Technology and hosted by Plexal, where I attended on behalf of Cyber Tzar, the Enterprise Supply Chain Risk Management platform.

Contents

What Is Due Diligence?

Due diligence is a comprehensive assessment conducted by potential buyers to verify the financial, legal, operational, and strategic health of your business. It’s a buyer’s opportunity to:

• Validate the valuation you’ve presented.
• Identify risks or liabilities that may affect the transaction.
• Ensure compliance with regulatory and contractual obligations.

A well-prepared business not only passes this scrutiny but also builds buyer confidence, potentially increasing the final valuation.

The Six Key Areas of Due Diligence

1. Customers

Buyers look for stability and predictability in your revenue streams.

What Buyers Assess:

• Customer Concentration: How much of your revenue depends on a few clients? High concentration increases risk.
• Contract Durability: Are contracts long-term and enforceable?
• Customer Satisfaction: Do you have strong relationships, positive feedback, and low churn?

How to Prepare:

• Secure multi-year contracts with key clients and maintain detailed agreements.
• Diversify your customer base to minimize reliance on a single client (aim for no more than 20% of revenue from one customer).
• Gather testimonials, Net Promoter Scores (NPS), or case studies to showcase customer loyalty.

2. Financials

Accurate and transparent financial records are non-negotiable.

What Buyers Assess:

• Revenue Trends: Are revenues growing, stable, or declining?
• Profitability: Does the business show healthy margins and cost control?
• Compliance: Are financials prepared according to GAAP or IFRS standards?

How to Prepare:

• Reconcile your accounts and ensure they align with GAAP/IFRS standards.
• Prepare detailed profit and loss statements, balance sheets, and cash flow statements for the past three years.
• Track revenue sources by customer, geography, and product to provide granular insights.

3. Technology

For businesses reliant on technology, this area can significantly influence valuation.

What Buyers Assess:

• Intellectual Property (IP): Who owns the IP, and is it protected?
• Scalability: Can the technology handle growth without significant reinvestment?
• Technical Debt: Are there outdated systems that may require costly upgrades?

How to Prepare:

• Ensure all IP is registered and assigned to the business (not individuals).
• Address technical debt by updating outdated systems and documenting future improvement plans.
• Prepare a summary of your technology stack and highlight recent upgrades or innovations.

4. Employees

A motivated and stable workforce reduces operational risk for buyers.

What Buyers Assess:

• Key Personnel Dependency: Is the business overly reliant on certain individuals, especially founders?
• Staff Retention: Are employee turnover rates reasonable and manageable?
• Legal Compliance: Are employment contracts clear and enforceable?

How to Prepare:

• Build a leadership team that can operate independently of the founder.
• Create detailed job descriptions, succession plans, and organizational charts.
• Review and standardize employment contracts, ensuring compliance with local labor laws.

5. Legal Compliance

Legal risks can derail a transaction faster than any other issue.

What Buyers Assess:

• Corporate Governance: Are shareholder agreements, board minutes, and corporate records up-to-date?
• Intellectual Property: Are trademarks, patents, and copyrights protected and enforceable?
• Regulatory Compliance: Are you meeting industry standards and legal obligations?

How to Prepare:

• Conduct a legal audit to identify and resolve potential liabilities.
• Regularly update shareholder agreements, cap tables, and corporate bylaws.
• Ensure compliance with applicable laws, such as GDPR for data protection or sector-specific regulations.

6. Sales and Operations

Buyers need assurance that your business can sustain and grow revenue post-acquisition.

What Buyers Assess:

• Predictable Sales Pipeline: Are future revenues predictable and achievable?
• Efficiency: Are operations streamlined and scalable?
• Market Position: How does your business compete in the industry?

How to Prepare:

• Use CRM tools to track and showcase your sales pipeline, including conversion rates and key metrics.
• Identify and resolve operational bottlenecks to demonstrate efficiency.
• Highlight competitive advantages, such as strong branding, market share, or unique selling propositions.

Creating a Data Room

A well-organized data room is essential for due diligence. This secure repository contains all critical documents that buyers will need to review. Key categories to include are:

1. Corporate Documents: Articles of incorporation, shareholder agreements, and cap tables.
2. Financial Records: Profit and loss statements, balance sheets, tax returns, and budgets.
3. Legal Agreements: Customer contracts, employment agreements, IP registrations, and lease agreements.
4. Operational Data: Organizational charts, key processes, and growth plans.
5. Technology Assets: IP ownership details, technical documentation, and recent investments.

Tip: Regularly update your data room as part of ongoing preparation. A clean, accessible data room signals to buyers that your business is well-managed.

Common Pitfalls to Avoid

1. Unresolved Liabilities: Pending lawsuits, tax issues, or regulatory violations can scare off buyers.
   Action: Conduct a pre-sale audit to identify and address risks.
2. Founder Dependency: A business overly reliant on its founder is less attractive.
   Action: Transition key responsibilities to other team members.
3. Inaccurate or Incomplete Records: Gaps in financial or legal documentation erode buyer confidence.
   Action: Hire professionals to review and organize your records.
4. Unrealistic Projections: Inflated forecasts can backfire during due diligence.
   Action: Base projections on historical trends and realistic assumptions.

Key Takeaways

1. Start Early: Due diligence preparation takes time—begin years in advance to address potential red flags.
2. Focus on Transparency: Clear, organized records inspire confidence and reduce buyer skepticism.
3. Mitigate Risks: Address liabilities, customer concentration, and founder dependency well before engaging buyers.
4. Leverage Experts: Work with legal, financial, and M&A advisors to navigate the process smoothly.

Next in the Series

In the next article, we’ll cover “Timing Your Exit: How to Align Business Readiness with Market Opportunities.” Discover how to choose the right moment to sell your business for maximum value.

Stay tuned for actionable strategies to make your exit as smooth and profitable as possible!