You may think that you have got a brilliant business and that buyers will be fighting over themselves to acquire it – but is it in a clean and tidy state?  Are there any skeletons in the cupboard that you know about and should really sort out before going on the market? Or worse, you may have undiscovered cupboards and skeletons! Conducting your own pre-due diligence is an effective way to get yourself and your business ready for the often arduous process of a company sale.

Pre-due diligence is the second step in Devant’s 7 step guide to a successful company sale. It will give the business a spring clean and help you identify issues that can be resolved in advance of a sale.  It won’t necessarily make the company sale process any less stressful for you, but by opening up those cupboards and clearing out those skeletons, you will be ahead of the game when you decide to look around for buyers, or when a potential acquirer comes calling.

A good place to start is to think about the things that a buyer will look at when examining your business.  It is worth remembering that once you get into a formal sales process you will have to prepare detailed responses to a buyer’s due diligence questions, and you will have to provide formal disclosures against warranties in the sale and purchase agreement, so checking these details now will make the process easier later on.

Let me take you into the various ‘rooms’ of your business that a potential buyer will wish to explore. Each of these areas (and more) has the potential to be a showstopper, either preventing the sale of your business from proceeding, delaying it significantly while the issues are sorted out, or cutting a chunk off the purchase price.

1. Share Capital and Company Records

Firstly, think about your shareholders and shares. Hopefully, you know what your shareholders will think about a possible company sale, but if you are a small privately owned business with only a couple of family shareholders, it is easy to lose focus on this aspect of your company while you are concentrating on building your business.  Are all of the shares fully paid up, and have all new issues of shares been properly minuted in board minutes and in your company’s registers and at Companies House?

If you have a number of shareholders and different share classes, you will need to be aware of the shareholder rights involved and authority to sell shares.  Do you have a shareholder agreement in place that governs this, or will you need to refer to the company articles of association? Do you have an employee share option scheme that brings other shareholders into play? What are your drag-along arrangements if you have some shareholders who might not want to sell at the moment?  Be warned, a single shareholder or a group of shareholders with a large enough shareholding can stop a sale going ahead!

Are all your statutory company books and records complete and up to date?  Have you complied with filing requirements at Companies House?  Buyers will want to examine your statutory records and minute books to ensure that they correspond with the company searches that they carry out. You should get those records in order now, even if it means reconstituting them from scratch.  Potential buyers are going to be very concerned about other aspects of your business if you haven’t kept these important records properly.

2. Contracts

Secondly, take a look at your contracts, both with customers and suppliers.  You can focus on the contracts you have in place with your key suppliers and important customers, but make sure you can find all of the correct signed copies of your contracts, including any subsequent contract variations or amendments.  Look at the contract period and any termination provisions. Are they all long-term contracts that will carry on and benefit a buyer of your company and that the buyer can rely on?  Or can an important customer or key supplier terminate when the contract comes up for renewal, or can they terminate for a change of control in your business?  You will need to be aware of which customer contracts are on your standard terms, and which have special arrangements in place, any contracts that have exclusivity restrictions that might impact on a buyer, and also whether any contracts are loss-making.  Are you in breach of any contracts, perhaps only in a minor way, or perhaps without realising it?  All of these (and more) could be flagged up by a buyer, affecting the amount they are willing to pay for your business and/or requiring you to give specific indemnities which could reduce the price you end up getting on a sale.

3. Accounts, Finances and Tax

Check over your accounts for the past few years with a critical eye.  A buyer will want to understand your revenue streams and cash flow.  Also, you may be accounting for things in a certain way that a buyer may not be happy with.  One of Devant’s clients was recognising on-going revenue in full up front and that was the key point that made their overseas buyer decide not to proceed with the purchase, as it didn’t comply with the revenue-recognition rules in their territory.

Do you have any potential bad debts that you should really have been making provision for?  Again, this is an issue where a buyer might require you to give an indemnity, in case those outstanding bad debts don’t get resolved.

Have you given security over any of the company assets or are there charges in place, such as mortgages on your office property? You may find that there are charges hanging around that have previously been dealt with, but still appear on Companies House.  You might have had an overdraft facility in place that you no longer need, or a loan that has been paid off.  Do you have all of the documentation in place to show what happened?  Contact your bank or lender if anything needs to be closed off so that any loose ends are tidied up. Again, any finance documents and arrangements with your bank may have change of control provisions, so you need to be aware of these and the implications prior to any sale.

Have you complied fully and accounted properly for tax?  Have you been subject to any tax investigations? Even if these resulted in no finding of any fault on your part, it will be helpful to have all the records together in one place to show a potential buyer.

4. Assets, IP and IT Systems

Depending on your business you might have lots of physical assets or less tangible ones such as software and other intellectual property.  Make sure that you have an up to date inventory or register of company assets such as equipment, stock, and vehicles.  What is their current state, and does it make sense to invest now to replace any ageing assets?

Check your software and the company’s intellectual property and associated rights, including patents, trademarks and registered or unregistered designs.  You will also need to be aware of all licenses that you have granted associated with these, including rights to use software that you have granted to your clients.  What are the terms of those licenses?  If you run a software company, you will need to check the terms and licences that you have from your suppliers, such as the providers of your hosting platform. You will also need to check that you have dealt correctly with any open source software that you use in providing your own software or services.  We recently helped the sale of a software business that had to change all of its terms with its clients due to their accidental misuse of open source software. Many organisations are not aware that they are using open source software, or that there are potentially restrictions associated with its use; make sure you know where you stand, and put in place any open source pass-through terms that might be required to ensure you’re compliant with the relevant open source licensing terms.

Other assets that you may own or license are your internal IT systems.  Again, make sure that your inventory of equipment and software is complete and up to date.  Check that you have valid licences in place for all of the third party software that you are using. You may find that you have too many licences or are still paying licence fees for software that is no longer used, which could be a useful cost saving and an unexpected benefit of your pre-due diligence work!

5. Company Property

If your company owns property that will form part of the sale, there will be a multitude of property searches, planning issues and property-related questions that a buyer’s property lawyers will want to ask about and carry out.

Where a property lease is involved, the buyer will want to check that it can take over the lease and continue to use the property as it requires, in order to continue the running of the business. Or, if the buyer has its own premises and wants to move your staff and operations there, they may want to know they’re able to exit a lease reasonably quickly. Whatever the situation, you should know what the current situation is, and where to find that information.

You will need to involve your own property advisers and lawyers in due course, but you can prepare by checking that you have all documentation such as property records, plans, valuations, transactions, mortgages, leases gathered together, and details of any property issues, such as structural issues, flooding, rights of way, disputes etc. that have come up in the past.  All of this will be required by a buyer, and if it is not in place, can cause significant delay to the sale process.

6. Litigation and Disputes

Your business has hopefully been run well, and you are on good terms with your clients and suppliers.  Any buyer of your business will want to look carefully at any disputes, however small, and will obviously want to know that any disputes that have escalated to litigation and all of the issues that caused the dispute in the first place have been fully resolved.  If there is a risk that more cases might arise in the future, a buyer will probably want an additional security (such as an indemnity) from the shareholders.  This could easily have a significant impact on any price that is agreed for the sale of the business.

7. Management and Employees

One of the most important assets in your business will be your supportive management team and loyal employees. A good management team indicates that your business will continue to be successful after you’re out of the picture.  So all being well, a prospective buyer will want to retain or transfer over your staff. You will need to make sure you have full details of your key employees and all aspects of their employment, including their salary arrangements, length of service, benefits, share options (if applicable), sickness, maternity or paternity arrangements and pensions.

What next?

There’s a lot involved in getting your business ready for sale, so do start early. With a potential sale in mind (even if it’s five years away) you will find that you pay more attention to all of the areas above, creating a ‘cleaner’ business as you grow and develop. This makes life so much easier when you do come to sell, and also means you’re in a better position if you receive a surprise offer for your company when you weren’t quite ready to put it on the market!

If you’d like to add value to your business and feel overwhelmed with the tasks ahead we can help you spring clean your business ready for a prospective company sale. Contact us for a free initial conversation in confidence.

Janine Scott
Senior Commercial Consultant