Selling a Business: How to Conduct Sell-Side Due Diligence

Selling a business is often a lengthy process, so it's best to prepare your middle market business for its sale up to three years before the actual transaction takes place. You might think that getting the best possible sale price depends upon timing the marketplace correctly, effective negotiation, and other externalities, but that isn't the case. The most important factor influencing the pre-sale valuation of your middle market company is your own due diligence.

It's inevitable that buyers will perform buy-side due diligence so they can understand and valuate what they're intending to purchase, but the seller should be doing the same thing. A thorough sell-side due-diligence process prior to the sale will give you a necessary, granular understanding of your middle market business, ensure that you have all required documents needed to support the sale, help you anticipate and react to buyer objections, and allow you to uncover and fix valuation-reducing problems. Here are six big questions that middle market sellers should be asking and answering when performing sell-side due diligence:

1. Is my business profitable, and can I show buyers that the profitability is sustainable? Make sure that you have solid financial systems in place to collect the relevant data, as buyers will want to scrutinize financial information for years prior to the sale. Every buyer will want to see a diversified and loyal customer base and competitive advantages in your product/service portfolio that are sustainable over time. You also need to show that your middle market business is mature enough to possess strong systems of control, especially in financial and sales areas.
2. What is my as-is valuation? An as-is valuation and a comprehensive analysis of your middle market company's weaknesses will provide you with a road map to boosting pre-sale value. Ask an expert to come in and provide a valuation with a detailed breakdown of your company's strengths and weaknesses. You'll also need to analyze the cost and potential added value of fixing problem areas uncovered as part of the expert's analysis. If you discover low-hanging fruit, meaning relatively simple, low-cost opportunities to increase your company's value, invest in those opportunities now. Most middle market companies justifiably focus large amounts of attention and resources on acquiring and retaining customers, so they can sometimes have gaps in their internal systems and processes. Close these gaps ahead of time.
3. Why am I selling? Think deeply about this question and have a well-considered answer with a positive spin ready, because this will likely be the first question that every potential buyer poses. Wanting to pursue personal interests or another business venture are acceptable reasons to sell. Deal-killing reasons would be "I'm exhausted from squabbling with the leadership team," or "I don't know where to take my middle market business in an increasingly competitive market." Think about your motivations, and be prepared to tell a story that won't damage your business's perceived value. If you're not sure about your story, run it by a trusted business advisor.
4. Have I proven that I, as an executive, am dispensable, and will my key employees remain after I leave? If the seller is perceived as indispensible to the operation of the business, it's a big red flag for potential buyers. You'll need to show structures of shared decision making and internal communication that aren't centralizing all authority to the seller. If you don't, you're offering the buyer a shell of a business that may very quickly empty of value when the seller/founder leaves the scene. Proving the post-sale continuity and sustainability of your middle market business must be a top priority. You also need to have a workable succession plan in place and a strategy for retaining your key talent. Seek to lock in high-performing employees before the sale with incentives or longer-term contracts.
5. Is my business fully transparent? Make sure all side deals, handshake deals, or undocumented agreements/understandings with stakeholders are fully documented before the sale, because if any such surprises arise post-sale, the sales agreement will likely hold the seller liable. If your company is facing any potential legal liability, work hard to settle matters before the sale.
6. Do I have a good sell team in place? You need to have trusted internal advisors that can help you during the sales process. You'll also need strong outside advisors: specialists with skills in valuation, finance, law, and negotiation.

Sell-side due diligence is a crucial first step in selling a business. When done right, it allows the seller to be aware of opportunities to enhance the business's value before the sale, and it allows for a more informed and faster sales process down the road. By asking and answering the six questions above, middle market sellers will be in excellent position to optimize value, both before and during the sale.

Boston-based Chuck Leddy is an NCMM contributor and a freelance reporter who contributes regularly to The Boston Globe and Harvard Gazette. He also trains Fortune 500 executives in business-communication skills as an instructor for EF Education.