What Is Due Diligence?
Due diligence is the process through which a buyer will uncover information about the business they’re considering purchasing. During the due diligence process, a buyer will request access to documents containing commercial, financial, and legal information. They may visit the business premises to evaluate the assets and operations, and they may request sensitive data.
Conducting due diligence is the last step before purchasing a business—the first step is finding a target company to purchase, and the second is signing a letter of intent. The smoother the due diligence process is, the more quickly your business might be purchased, so it’s worth knowing what prospective buyers will ask for during due diligence.
The Types of Due Diligence
Essentially, there are four types of due diligence, all of which are part of the process. They are:
Commercial due diligence, in which competitive positioning, growth opportunities, supply chain, R&D, and other competitive factors will be considered. This process also includes an evaluation of a company’s overall operations (management, infrastructure, and more).
Legal due diligence, in which intellectual property rights, compliance, pending lawsuits, litigation risks, and other legal and regulatory aspects are considered.
Financial due diligence, in which a company’s financial health is evaluated.
Tax due diligence, sometimes considered a part of financial due diligence, in which tax exposure, back taxes, and overall tax burden are evaluated.
We can also consider due diligence in two broader categories:
Hard due diligence, in which numbers are data are evaluated—lots of paperwork, lots of accounting, and lots of triple-checking figures
Soft due diligence, in which the “human element” is considered—the customers, the employees, the vendors, and other stakeholders.
The Due Diligence Process
As you can probably tell, procuring all of these documents, crunching the numbers, and assessing the viability of a business takes a lot of time. During this process, the seller must be cautious not to reveal too much at once—there’s no point in preparing documents or information for a buyer who is going to back out after the first step of the process.
As such, your business broker will prepare, with the letter of intent, a document detailing when access will be provided to certain documents and stakeholders. The buyer will be able to access some documents immediately after signing the letter of intent—others will have to wait for it.
Documents like corporate tax returns, accountant financial statements, employment agreements, and T4 & T4A statements will usually be made available immediately. Bank statements and general ledgers will usually be made available afterwards—customer contracts after that, and permission to speak to key customers (if allowed at all) even later still.
Generally, permission to speak to employees, contractors, and vendors is not granted during due diligence. Soft due diligence can be performed through conversations with the seller—speaking to other stakeholders could lead to some unintended consequences.
Business transactions are tricky at the best of times, and selling your business can be a lengthy and intimidating process. Due diligence allows buyers to assess potential risks and determine whether or not the company they’re looking to purchase is a good fit.
There are significant risks involved when due diligence is botched—fortunately, you don’t have to check off the due diligence checklist yourself. As a small business broker in Vancouver, Jason Brice can prepare you for the due diligence process, help you acquire and prepare documents, and more.