A Founder’s Due Diligence Checklist for Selling a Business

The due diligence phase of selling a business is notoriously labor-intensive. If, however, your management team arrives at this stage of a transaction prepared with the right materials, you will experience a far more efficient process with a higher likelihood that the deal closes.

How far in advance should a founder prep these materials? The sooner the better.

Why You Need to Prepare for Diligence Now

When a legitimate offer comes along, as a founder you want to be in a position to act quickly and engage in a smooth process. Preparing early will help you:

• Minimize diligence risk. Being upfront about potential issues a buyer/investor might bring up will help you to maintain momentum and improve the likelihood of closing a successful deal. Neither you nor your buyer want surprises popping up during the confirmatory diligence process.
• Stay focused on business performance. Directing too much of your attention on diligence and away from the business can negatively impact business performance. This opens up the potential for last minute changes in terms or valuation. Preparing materials early can minimize distractions and lower this risk.
• Save time and headaches later on. When you have all the right materials gathered and organized early, the stress of diligence won’t be as acute.

So what materials do you need to prepare? Diligence falls into two primary categories: business and legal. Below are the key materials for each that, as a founder, you should start preparing early on.

Business Diligence

☐ Financials. A company’s financials constitute the most important data buyers/investors use to determine the quality of an acquisition (outside of product synergies).

Materials:

• Monthly financial statements in Excel (i.e. Income Statement, Balance Sheet, Cash Flow Statement, and Changes in Owner’s Equity). Note that if there are multiple businesses involved in the transaction, consolidating them all into one set of financial statements from day one will save time and effort.
• Monthly revenue (or bookings/billings) by customer. Note that, if possible, these files should 1) be calculated on an accrual basis, and 2) be easily reconciled to the revenue shown on the income statement.
• COGS breakdown
• AR & AP Aging
• Deferred revenue waterfall
• Accounting policies

Your income statement and monthly revenue by customer documents are the end-all-be-all materials for an acquirer to evaluate your business. Using these documents, buyers will 1) build out a financial model and 2) conduct a retention and customer concentration analysis (or similar analyses depending on your business model). In the earlier stages of the process, you will want to provide anonymized versions of your revenue by customer data.

☐ HR. HR data gives buyers/investors a sense of company structure as well as where you may have hiring gaps or redundancies. Your HR team should keep an ongoing employee census that includes start & end dates, salary, benefits, etc.

Materials:

• Employee census (including current and historical employees). As with the monthly revenue by customer data, this file should be easily reconciled to the income statement.
• Org chart
• Open positions

☐ Product. Product materials help buyers/investors understand how you price, market, implement, and plan your product. Often, these materials are fairly easy to gather as you use them internally or with prospects/customers.

Materials:

• Pricing models
• Marketing materials
• Deployment/implementation details
• Product roadmap

In some cases, sharing your product strategy with certain buyers/investors would be disadvantageous (such as with a competitor). Under these circumstances, you can stage product roadmap disclosure for later in the process to avoid giving information to parties you don’t end up transacting with.

☐ Tech. Buyers/investors want to understand the underlying tech stack that supports your product so they can identify potential synergies and product alignment, as well as potential technical debt. They will also want to understand dependencies on external vendors and code libraries.

Materials:

• Tech stack infrastructure
• Third-party licenses
• Open source usage

Your technology stack schematic should detail hosting and data protection infrastructure. Third-party licenses and open source usage are less important during a buyer or investor’s initial review, but more so during confirmatory diligence. Strategic buyers will often run an independent software scan to understand that the business has the proper licenses for open source software they’re using.

☐ Customer data. In addition to evaluating the raw data outlining customer growth and retention, buyers and investors like to get an understanding of opportunities within your customer base. Specifically, they might look for potential cross-selling opportunities or product gaps to reduce future churn.

Materials:

• Churned customers with reasons for churn
• Customer acquisition process and case studies on key customer "wins"
• Key reasons why you win/lose against competitors during customer acquisition
• Feedback surveys and Net Promoter Score (NPS)
• As much data on your customers as possible, including:

• Geographic location
• Number of employees and customers
• Product pricing tier
• Acquisition channel (paid, organic, referral, etc.)
• Usage rates of your product

Legal Diligence

☐ Corporate governance/structure. Corporate governance documents help buyers/investors structure the deal for tax purposes. A cap table will help them understand how to structure the deal, including equity rolls and liquidity considerations.

Materials:

• Articles of incorporation
• Operating agreement
• Financing documents
• Detailed cap table

☐ Tax. Buyer/investors will require tax documentation later in a process to understand potential risks or taxes owed.

Materials:

• Tax returns
• Bank statements
• Sales by state
• Sales tax, Nexus studies, and VDRs if applicable

☐ Contracts. Buyers/investors will need to know the contractual obligations they would acquire together with your company.

• Employment
• Vendor
• Partners/Resellers
• Customer

☐ Intellectual Property. Buyers/investors will want to understand what you own and what you license in terms of IP, as well as if you’re following the protocols of a licensee.

Materials:

• Trademarks, patents, copyrights, etc.
• Material license agreements
• Data privacy statements

☐ Litigation and legal compliance. Buyers/investors will request details of any litigation history or compliance protocols.

☐ Insurance. Buyers/investors will want to understand what insurance policies you have in place to evaluate coverage and potentially add more. Insurance materials will be more relevant during the final confirmatory stage of diligence.

☐ Property. Especially in the case of an M&A event, buyers will want to understand what physical assets they acquire with the business, as well as lease information.

Sharing Diligence Materials via a Data Room

The best way to stay organized when sharing all these materials with multiple buyers is to utilize a virtual data room. A data room is a hosting platform that enables secure, confidential sharing of diligence documents with your various buyers.

Beyond the benefits of organization and security, data rooms are helpful in a transaction because you can see who has engaged with which documents and when. This engagement data provides a lens into a buyer or investor’s diligence process. The more engaged they are, the more likely they are to move forward in the transaction.

Working with An Investment Bank to Support the Sell-Side Diligence Process

The ultimate indicator of a well-organized diligence process is that the process is largely confirmatory, meaning that by the time you enter exclusivity with a buyer/investor, they’re just double-checking the facts and nothing unexpected arises.

While diligence is certainly never enjoyable, you don’t have to bear the burden alone. Working with an investment bank can help ease the stress of diligence and ensure everything stays organized.

This material and the opinions voiced are for general information only and are not intended to provide specific advice or recommendations for any individual or entity.