If you are thinking about selling your business in the next one to three years, working with an experienced business attorney early in the process can make a significant difference in how smoothly that sale goes. The single biggest mistake most owners make is waiting until a buyer shows interest before getting organized. By the time a letter of intent is on the table, due diligence moves fast, and any gaps in your records can slow the deal down, reduce your purchase price, or in some cases cause a buyer to walk away entirely.
The good news is that most of what buyers look for is well within your control if you start early. Here is a due diligence checklist to help you get ahead of the process.
Get Your Financials in Order
Buyers and their lenders will want at least two to three years of clean financial statements. Ideally financials that have been reviewed or audited rather than simply prepared internally. If your books mix personal and business expenses, or if your revenue recognition practices are inconsistent, now is the time to clean that up. A buyer’s accountants will run a quality of earnings review. Any surprises they find during that process tend to work against you at the negotiating table.
Organize Your Contracts
Pull together your material contracts, including customer agreements, vendor agreements, leases, and any licenses or permits your business depends on. Look closely at whether any of these contracts contain a change of control provision, since many commercial agreements require the other party’s consent before an assignment or sale can take place. Discovering a change of control restriction mid-negotiation is one of the more common reasons a deal timeline slips.
Address Any Outstanding Legal Issues
Pending litigation, unresolved employee disputes, or unclear intellectual property ownership will all surface during diligence. It is far better for you to identify and address these issues before a buyer does. If your business relies on trademarks, trade secrets, or proprietary processes, confirm that ownership is properly documented and that any independent contractors or former employees signed appropriate assignment agreements.
Understand Your Deal Structure Options Early
Whether your sale will be structured as an asset sale or an equity sale has a significant effect on your tax outcome and your ongoing liability exposure. The structure of the transaction can significantly affect the seller’s tax treatment. In an equity sale, shareholders may generally recognize capital gain on the sale of their equity, while an asset sale can produce a combination of capital gain and ordinary income depending on the assets being sold, purchase-price allocation, depreciation recapture, and the seller’s entity structure.
If your business is structured as an S corporation or as a subsidiary of a corporate seller, a Section 338(h)(10) election is sometimes used to let the parties treat what is legally a stock sale as an asset sale for tax purposes, which can benefit the buyer through a stepped up basis while preserving some of the simplicity of a stock deal for you as the seller. This is a highly fact specific decision, and it is worth discussing with your attorney and accountant well before you go to market rather than after a term sheet is signed.
Prepare for the Letter of Intent
Once a serious buyer emerges, you will typically receive a letter of intent. The LOI outlines the proposed price, structure, and key terms before a full purchase agreement is drafted. While we would advise you to hire an M&A or business attorney beforehand, the LOI stage it typically when legal counsel it sought. An LOI is usually non-binding on price and structure but often contains binding provisions on exclusivity and confidentiality. Read those binding provisions carefully, since agreeing to an exclusivity period locks you out of negotiating with other buyers for a defined window of time.
Think About What Happens After Closing
Many sellers focus entirely on getting to a signed agreement and give little thought to what comes after. Will you be asked to stay on for a transition period? Will part of your purchase price be held in escrow or structured as an earn-out tied to future performance? Will you be bound by a non-compete or non-solicitation provision, and if so, for how long and in what geographic area? These terms are heavily negotiated and can meaningfully affect the real value of your deal, so it helps to think through your preferences before they show up in a draft agreement.
The Bottom Line
Selling a business is rarely a quick process, and the owners who get the best outcomes are almost always the ones who started preparing well before they needed to. While this due diligence checklist is a good representative sample, not all issues are covered here. If you are considering a sale in the near future, an early conversation with a business attorney can help you identify gaps in your records and structure now, while you still have time to fix them.
This blog is for informational purposes only and does not constitute legal advice. If you are considering selling your business, contact Brown & Blaier, PC to discuss your specific circumstances.