This blog series explores the steps in buying and selling a business, which tend to be much more complex than many business owners realize. In my last three blog posts, I explained what a letter of intent is, and why entering into a letter of intent is a critical first step in purchasing or selling a business. Once the parties have signed their letter of intent, the next step is due diligence. Due diligence, in this context, means investigation and reliability.
Investigation. The purchaser needs to find out more information about the business in order to enter into the transaction in a thoughtful, prepared fashion. And, the seller may need to investigate the purchaser. The letter of intent will generally contain language regarding the due diligence process. Most of the due diligence will, naturally, be conducted by the purchaser. The letter of intent often states that, subject to a nondisclosure agreement, the purchaser will have access to: (1) key people who possess knowledge of the business, including the seller’s employees, accountants, and other representatives; and (2) key documents, including the business’s financial documents, business agreements, and the governance documents related to the creation and maintenance of the business entity. Additionally, the letter of intent may indicate that the seller will conduct due diligence related to the purchaser, especially if financing is involved related to the purchaser price. The seller needs to make sure that the purchaser has the financial ability and resources to make good on its promises to pay, even if problems arise in the business after the transaction has closed.
Reliability. Often I find that parties who enter into a purchase and sale transaction without being represented by an attorney fail to understand the magic of due diligence. They might say, “Oh sure, we did due diligence. The seller, George, printed out three years of financial statements from QuickBooks and handed it to me. We’re good.” However, George may have forgotten to mention to the purchaser that he had hired his meth-addicted nephew, Larry, to do the bookkeeping for the last five years. Larry often came to work high, and had no idea what he was entering into QuickBooks. Or, something more nefarious may have occurred, in which George doctored up the QuickBooks a bit in order to make the business appear more profitable. In those scenarios, purchasers who failed to hire an attorney and take the due diligence process seriously can be seriously harmed, once they come into the business and discover that all is not as it initially appeared to be. Due diligence creates a more formalized mechanism for producing documents and financial records, in which written requests for a wide variety of documents are made, documents and records are produced in accordance with the written request, and key documents may be referenced in the upcoming purchase and sale agreement, attached as exhibits, and guaranteed in regard to accuracy. In other words, if the seller provided material information to the purchaser that later proved to be inaccurate, and the issue proceeded into litigation, a solid record has been created so as to greatly enhance the purchaser’s chance of recovery.
What types of information are requested during the due diligence process? Please read my next blog post to find out!
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