Due Diligence When Selling a Business in the UK: What Sellers Need to Know
Due diligence is the stage of a business sale where the buyer and their advisers investigate the business in detail to verify everything you have told them and to identify any risks or issues they need to understand before completing the purchase. For a well-prepared seller with nothing to hide, due diligence is largely a process of confirmation that moves the deal forward. For a seller who is unprepared or who has undisclosed issues in the business, it can be a source of significant delay, price renegotiation or deal failure.
Understanding what happens during due diligence and how to prepare for it is one of the most valuable things you can do before you go to market to sell your business.
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What Is Due Diligence in a Business Sale?
Due diligence is the formal investigation process a buyer conducts after a price has been agreed in principle and heads of terms have been signed. It is the buyer's opportunity to verify that the business is as described, that the financial information provided is accurate, that there are no undisclosed liabilities or legal issues, and that the business can be transferred to new ownership without material disruption.
Most business sale due diligence processes cover three main areas: financial due diligence, legal due diligence and commercial due diligence. For larger or more complex transactions, operational and technical due diligence may also be conducted. The scope and depth of due diligence varies with the size and complexity of the business and the buyer's appetite for investigation, but even for smaller SME transactions, a thorough buyer will examine a significant range of documents and ask a large number of questions.
Financial Due Diligence
Financial due diligence is typically conducted by the buyer's accountants and focuses on verifying the financial performance of the business. The starting point is confirming that the historical accounts match the information you provided in your information memorandum and that the adjusted earnings figure you have used to support your asking price is accurate and well-evidenced.
Financial due diligence will typically cover three to five years of annual accounts, recent management accounts, the adjusted earnings calculation and all add-backs, working capital levels and trends, cash generation and the relationship between profit and cash, any off-balance-sheet liabilities, tax compliance and any outstanding HMRC matters, and the terms and conditions of any debt or financing facilities.
The most common issues that arise in financial due diligence are add-backs that cannot be adequately evidenced, inconsistencies between the accounts and the management information provided, working capital that is lower than the normalised level assumed in the pricing, and previously undisclosed tax issues. Each of these can cause delay, renegotiation or in serious cases deal failure. The way to prevent them is to identify and address them before the buyer finds them.
Legal Due Diligence
Legal due diligence is conducted by the buyer's solicitors and covers the legal structure and compliance position of the business. It focuses on confirming that the business has clean legal title to its key assets, that its key contracts are valid, current and transferable to a new owner, and that there are no undisclosed legal liabilities or compliance issues.
Legal due diligence typically covers the constitutional documents of the company, the ownership structure and any shareholders agreements, key customer and supplier contracts and any change-of-control or assignment provisions within them, premises leases and any landlord consent requirements for assignment, intellectual property ownership and registrations, employment contracts, policies and any pending employment disputes, regulatory licences and compliance with applicable regulations, and any litigation, disputes or material claims against the business.
Change-of-control clauses in key customer or supplier contracts are one of the most common sources of legal due diligence risk. If a key customer contract gives the customer the right to terminate on a change of ownership of the supplier, that is a material risk that needs to be managed carefully. Identify any such clauses before going to market and take advice on how to handle them with the relevant counterparties.
Commercial Due Diligence
Commercial due diligence focuses on the market position, competitive environment and growth prospects of the business. It asks whether the business is as competitively strong as the seller suggests and whether the revenue and profit levels are sustainable under new ownership. For smaller transactions this is often conducted informally through management meetings and questions rather than through a formal report, but for larger deals a buyer may commission a formal commercial due diligence report from an independent adviser.
Commercial due diligence typically covers the customer base and concentration risk, the quality and tenure of key customer relationships, the competitive landscape and the business's market position within it, the key revenue drivers and their sustainability, any significant trends in revenue, margin or customer behaviour, and the dependency of the business on the outgoing owner and key individuals.
How to Prepare for Due Diligence as a Seller
The best preparation for due diligence is to conduct a vendor due diligence exercise on your own business before you go to market. Work through the documents and questions a buyer's advisers are likely to raise and address any issues you find before the buyer finds them. This approach consistently produces faster, smoother due diligence processes and better outcomes for sellers.
Prepare a well-organised data room before your listing goes live. A data room is a secure, organised repository of all the key documents a buyer will need during due diligence, typically hosted on a secure online platform. Organising your documents in advance means you can respond to any due diligence request immediately rather than spending days or weeks pulling together documents after a buyer asks for them.
The key documents to include in your data room are three to five years of annual accounts and recent management accounts, the adjusted earnings calculation with supporting evidence, constitutional documents and shareholder agreements, key customer and supplier contracts, premises leases, employment contracts for key staff, intellectual property registrations, regulatory licences, details of any insurance policies, and information about any litigation or disputes. For a full guide to preparing your business before going to market, read our article on how to sell your business in the UK.
Managing Due Diligence Once It Starts
Once due diligence begins, your primary job is to respond to buyer requests promptly, completely and accurately. Slow or incomplete responses to due diligence requests are one of the most common causes of deal delays and one of the most effective ways to erode buyer confidence at a critical stage of the process.
Set up a clear process for managing due diligence requests. Designate a single point of contact on your side for all due diligence communications. Acknowledge every request promptly even if you need a short amount of time to gather the information. Respond completely rather than providing partial answers that generate follow-up questions. Flag any issues proactively rather than waiting for the buyer to ask about them.
If an issue arises during due diligence that was not previously disclosed, deal with it openly and early. Buyers who discover issues that should have been disclosed are far more likely to renegotiate significantly or withdraw entirely than buyers who are told about an issue proactively by the seller with a clear explanation of the context and impact. Honesty and transparency in due diligence consistently produces better outcomes than hoping issues will not be found.
Due Diligence and the Sale Price
Due diligence can result in a price adjustment if the buyer discovers material differences between what was represented and what the investigation reveals. The most common causes of price adjustment in due diligence are an adjusted earnings figure that does not hold up under scrutiny, working capital that is below the level assumed in the pricing, undisclosed liabilities that emerge during legal due diligence, and significant customer concentration or contract risk identified during commercial due diligence.
The best protection against a price reduction in due diligence is thorough preparation before going to market. A seller who has verified their own financial information, addressed legal issues in advance and presented the business accurately in the information memorandum will rarely face a material price adjustment in due diligence. A seller who has overstated the adjusted earnings, failed to disclose significant issues or presented an unduly optimistic picture of the business should expect significant renegotiation when the buyer investigates.
Frequently Asked Questions
How long does due diligence take when selling a business?
For a well-prepared business with a comprehensive data room, financial and legal due diligence typically takes four to eight weeks. For businesses where documentation is incomplete or issues are discovered that require further investigation, it can take twelve weeks or more. Preparation is the most effective way to speed up the process.
Can I refuse to provide information during due diligence?
Sellers are not legally required to disclose information beyond what is required by the warranties and disclosure process in the sale documentation. However, refusing to provide information that a buyer reasonably needs to complete their investigation will typically cause the buyer to withdraw or significantly increase the protections they seek through warranties and indemnities. A cooperative, transparent approach to due diligence consistently produces better outcomes.
What happens if due diligence reveals a problem?
The outcome depends on the nature and severity of the issue. Minor issues are often addressed through a modest price adjustment or an indemnity in the legal documentation. More significant issues can result in a larger price reduction or, in serious cases, the buyer withdrawing from the deal. Disclosing known issues before due diligence begins gives you the best chance of managing them constructively.
Do I need to do anything to prepare for due diligence?
Yes. Preparing a comprehensive, well-organised data room before going to market is the single most effective thing you can do to speed up due diligence and improve its outcome. Conduct a review of your own business from a buyer's perspective before listing, address any issues you find and ensure all key documents are current, complete and readily accessible.
Sell Your Business With Confidence
A well-prepared seller has nothing to fear from due diligence. World Businesses For Sale connects UK business owners directly with serious buyers from across the UK and worldwide, with no commission charged on completion.
List your business for sale today or read our complete guide on selling a business in the UK.
This article provides general information only and does not constitute legal, financial or professional advice. Always obtain independent professional advice before making decisions about selling your business.