Due diligence items when selling a business
There are many critical stages when selling a business or buying a business. As a business broker that specializes in the sale of a business or practice, I always put in a lot of time and effort to make sure that I can present the business/practice and the seller in the best light possible before marketing to attract buyer interest. My view is that the higher the quality of the work I do upfront, the greater my chances of the seller and buyer achieving their ultimate goal which is to respectively sell their business and buy their business.
The result of this initial effort will or will not matter when the seller and the buyer get through the tough part of meeting and getting to know each other, negotiating the deal (which can be draining and demanding) but then have it all fall apart during due diligence generally because what the buyer thought they were buying is different to what they thought they had been told. At the moment I am dealing with some buyers that wish to buy a Primary Care and Urgent Care clinic. Their due diligence list has 182 items on it. They want to know what they are buying and are leaving no room for error.
So let’s have a look at a few items that a seller may help during the due diligence phase of selling their business and achieve their ultimate goal to sell their business. These are only a few items and by no means exhaustive.
Seller finance is involved in almost all transactions.
Seller finance is involved in almost all transactions. A seller can protect themselves by:
Getting personal guarantees from the buyer
If the seller is going to allow seller finance and there is another primary source of finance such as an SBA loan, understand the seller will lose loan payment priority and have to subordinate to the other lender on security interests. The bottom line – it may make better sense for the seller to carry more finance and eliminate the SBA loan.
If real estate is part of the transaction, ensure Deeds of Trust are executed correctly.
Earnouts
Earnouts fit some transactions while they don’t fit others. An earnout where the buyer repays the seller from the ongoing operation of the business can be a win for the buyer and a win for the seller.
It generally comes into play when the seller believes the business will continue to grow even when there is a change of ownership to a new buyer. However, a seller should keep the terms of the earnout simple to prevent buyer and seller arguing about what is and isn’t part of the earnout.
Also, the seller should protect their interest by defining how and when the buyer presents the financial statements or accounting so they don’t feel the buyer is manipulating the results to lower the payment of the earnout.
Make it clear that what happens if the buyer ‘gets an offer for the business they cannot refuse.’
Terminating employees
If the business has a number of employees and the seller wants to make sure they dot their i’s and cross their t’s, it can be a good investment to have an attorney that specializes in labor law make sure everything is being done correctly.
For example, make it crystal clear whether the employees are being terminated by the seller at the close of escrow and hired brand new by the buyer.
This includes whether or not any unpaid holiday pay goes directly to the employee from the seller or from the seller to the buyer who wants to keep that pay and use it as leverage to make sure the employee doesn’t request time off as soon as the buyer takes over the business and makes it harder for the buyer.
Worse still, the seller may think he’s sold the business and moved on to bigger and better things but now finds they are dealing with a law suit. This is because an employee doesn’t like their new owner and the new owner certainly doesn’t like the employee and so they were terminated only to find the sellers been caught in a wrongful termination law suit that the buyer set in motion and the employee figures they may as well drag in the seller as he has plenty of money from just selling his business.
Disclose, disclose, disclose.
My favorite safety net for a seller is to disclose, disclose and disclose. It’s pretty hard for a buyer to with-hold money or sue for money by saying something happened or didn’t happen the seller said or agreed on when the buyer was fully informed.
Non-compete agreements
Most attorneys will advise that non-compete agreements restricting an employee to do or not to do anything in California is not good business.
Buyers and sellers typically come to an agreement on some non-competes include a geography that the seller agrees not to do any business but keep all non-compete agreements very simple. I’ve seen deals fall apart where the ONLY thing the seller and buyer cannot come to an agreement about is a non-compete.
Making a deal to sell a business and/or buy a business is very hard without a third party to provide some objectivity in the deal. Being a business broker and being active in the deal making is the hardest part of the transaction. The next hardest part is making sure each party is able to deliver on their agreements. It is very common for a deal to implode because the two parties are locked over “one last thing.” Often that “one last thing” is simply a culmination of the seller thinking he’s given up too much and the buyer thinking exactly the same thing. The best recourse is to pull back from the negotiations and then try again. However, it’s during due diligence when the deal will make or break as both sides need to allow the other party to check and verify their representations.
If you would like more information about selling your business please visit my webpage Sell a business; or buy a copy of my book Successfully sell your business. If you would like more immediate help with selling your business you are welcome to send an email to Andrew Rogerson; or give me a call on 916 570-2674.
