Preparing for the sale of a business: Legal due diligence

The legal due diligence process is a frequent source of delay and aggravation when selling a business. All too often, busy business owners must spend their time — and legal counsel’s billable time — to gather documents that are not well organized and respond to multiple follow-up due diligence requests.

Business owners can help streamline this process by taking time, prior to going to market, to organize the materials that potential buyers are likely to request.

Business owners are often taken aback by the scope of potential buyers’ legal due diligence. Usually, potential buyers kick off their legal due diligence by providing due diligence request lists.

Frequently, business owners are frustrated by the length and comprehensiveness of these lists. It is not unusual for these lists to be 15 to 20 pages long, or even longer.

Here, I typically tell clients not to attempt to “fight the process.” In practice, complaining about the length of due diligence request lists almost always takes more time — and leads to more consternation — than would be involved in simply responding to them. Pushing back on request lists also can cause potential buyers to question what sellers might be hiding. This, in turn, often leads to additional — and more intrusive — due diligence requests.

The better course of action is to respond comprehensively to due diligence request lists in a timely and organized manner. Many items on a due diligence request list will likely not be applicable to a particular business. Buyers’ counsel will typically ask that sellers simply indicate on the request list that these items are not applicable. The reality is that buyers’ counsel typically do not “know what they don’t know” about a business. By asking a “standard” set of questions and then having sellers quickly respond that certain questions are not applicable, buyers’ counsel are able to “tick and tie” their files and move on quickly from topics that are not relevant to the business in question.

But, prior to taking their companies to market, what can business owners do to make the process of responding to these requests less painful? Most centrally, business owners should organize their companies’ books and records, particularly the types of documents that potential buyers are likely to request. Without getting into specific detail, areas upon which potential buyers typically focus include the following:

1. Organizational and governance documents. Potential buyers will want to see organizational documents, such as articles of incorporation (for corporations) or organization (for limited liability companies), bylaws (for corporations) or operating agreements (for limited liability companies). Potential buyers will also typically want to see books and records — such as meeting minutes — relating to the company’s governance.
2. Capitalization. Potential buyers will want to understand the company’s capitalization. It can be very helpful to have a well-organized capitalization table, especially if the company has numerous owners. Potential buyers will also want to see other agreements relating to the ownership of the company, such as shareholders’ agreements.
3. Contracts. Potential buyers will want to see the company’s key contracts, such as contracts with customers and suppliers.
4. Indebtedness. Potential buyers will want to understand the company’s indebtedness and see all documentation relating to that indebtedness.
5. Real Estate. Potential buyers will want to understand the real estate owned, leased or otherwise used by the Company and will want to review any real property leases.
6. Intellectual property and information technology. Potential buyers will want to understand the intellectual property, IT systems and related items and assets that are used in connection with the company’s business.
7. Litigation. Potential buyers will want to understand any litigation involving the company, as well as any threatened litigation.
8. Labor & Employment. Potential buyers will want to review a list of the company’s employees and contractors. Potential buyers will also want to review company’s practices and procedures relating to employees and contractors and any agreements between the company and its employees or contractors.
9. Insurance. Potential buyers will want to review the company’s insurance policies.
10. Other regulatory and compliance considerations. Potential buyers will want to understand potential regulatory and compliance risks relevant to the business. This could include areas such as environmental compliance, data privacy, health care licensing or other relevant areas.

The above list is not exhaustive. However, it should provide a sense of the types of legal due diligence requests that potential buyers are likely to make regarding a business.

Of course, certain documents — most frequently customer or supplier contracts and customer or supplier lists — are particularly sensitive. Experienced counsel can help clients identify strategies for responding to potential buyers’ reasonable due diligence requests while protecting this proprietary information.

An experienced mergers and acquisitions attorney can help guide a business owner through the legal due diligence process. Gunster has extensive experience assisting business owners with all aspects of sale transactions, including the due diligence process.

Joseph P. Chase is a corporate lawyer and shareholder at Gunster in West Palm Beach. 

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