Due Diligence for Business Exit
Whether you are thinking about, preparing for, or are in the middle of selling your business – what you need to be aware of is that it can be a lengthy process. There are various stages which you’ll need to go through in order to achieve a successful exit.
Due diligence is a significant part of selling your business. It is undertaken by the buyer and involves them collecting and checking sound and reliable information and records that will help them understand the viability of your business. By completing due diligence, the buyer is able to decide whether they want to proceed with the purchase of your business or not, and even determine how much they’re prepared to pay for it. It is for this reason that due diligence is a particularly pivotal point in the process and can make or break for your business deal. In fact, a whopping 50% of small business purchases collapse at this stage because the due diligence carried out is unable to maintain the buyer’s confidence.
What does this mean for you as the seller? Firstly, it highlights that you will need to be willing to disclose sensitive information regarding your business finances. Transparency will help ensure a smoother due diligence process. Secondly, it suggests you should be organised in having as much of the information available for the potential buyer when they ask for it as delays will prolong the process and may frustrate the purchase. Thirdly, you should avoid attempting to hide any negative information you may have on your business as honesty will be much more likely to reassure a buyer than them finding the information through their own accord.
One of the most critical aspects of your business that a buyer will be interested in is, of course, the financial records. This is where your accountant comes in. Here are the top 3 things you should ask your accountant to help you prepare for:
1. Profit and loss (P&L) statement for the current and past 2-3 years for due diligence
At its simplest, a P&L report will show all income generated by the business as well as deductions to that income from the costs and outgoings incurred by running the business. It will allow a buyer to see how profitable the business has been over a period of time. It’s wise to provide records for the previous few years as well as the current year as it may be the case that the business has become more and more profitable over the years, or that there may have previously been a dip that you were able to recover from. The P&L indicates to a buyer the opportunity to generate more profit by increasing revenue or reducing costs or both. If you have been receiving regular P&L statements from your accountant and using them to make informed decisions to improve the business then this will only make for convincing evidence to the buyer as to why they should buy your business.
2. A current up-to-date balance sheet for due diligence
Unlike a P&L statement which shows how your business has performed over a period of time, a balance sheet instead presents your financial status in a single moment in time (usually your most current balance sheet will be requested by the potential buyer). A balance sheet is useful because, as a business, money will constantly be coming in and going out, so therefore a single snapshot can provide a clear overview. A balance sheet also shows different information and includes your assets, liabilities and business equity. Assets and liabilities are split between current and noncurrent. Current assets are considered to be those which can be readily liquidated into cash such as inventory or cash itself, including unpaid invoices. Noncurrent assets, on the other hand, are those which cannot be quickly turned into cash such as machinery or property. These can include intangible assets such as patents. Again, with liabilities, current liabilities are those which need to be paid relatively quickly (within a year) such as your tax liability or accounts payable. Whereas noncurrent liabilities are longer-term debts such as long-term lease obligations or long-term bank loans. Equity is really the result of all your liabilities deducted from your assets.
3. Cash flow statement for due diligence
Cash flow statements show the movement of actual money going in and out of your business over a particular period of time. This means that it will not account for money owed, such as when you have sent out an invoice and not yet received payment, or when money is due to be paid such as when you purchase goods using credit. Although a cash flow statement does not provide an accurate picture of profitability, it is still a key report to provide to potential buyers that can give them a sense of confidence in buying your business. Where possible, you will want to be able to show a positive cash flow which means that there is more money coming into the business than going out. A negative cash flow will show the opposite and can indicate that your income and expenses are not well-coordinated. However, a cash flow statement is made up of three parts – operations, investing and financing. In some instances, a negative cash flow can actually be seen as a positive so it’s important that you learn to understand your cash flow statement to be able to explain to buyers if they have concerns. Where you may have a negative cash flow under investing such as from leasing or purchasing additional premise; this can demonstrate the ability of your business to expand or continue developing. Where you have a negative cash flow under financing means that you are paying off loans and debts. These are all positives, so be sure to be prepared to answer questions when it comes to your cash flow.
This is of course not a comprehensive list of how your accountant can help when it comes to preparing for due diligence, but by working with your accountant to fully understand and be able to explain these fundamental financial records to your potential buyers will validate how in-touch you are with your business.
This article was originally written as a guest blog post for our clients ETSC, Corporate Business Brokers and Exit Strategy Specialists.