We continue to post chapters from our upcoming ebook guide, How to Sell an Online Business, to help business owners prepare for a sale. In this sixth and final chapter, we look at the seller's role in buyer due diligence and the documents needed to close the sale.
6. Due Diligence and Closing Documents
Once a letter of intent or similar document has been signed, the next step is for the buyer to conduct a more formal due diligence. The buyer’s main goals in due diligence are to confirm that the business is in fact as presented, and to gain a clear understanding of the risks and opportunities associated with the business. The high-level areas of focus for due diligence are legal, financial, business operations, and market.
Legal
Legal due diligence is to assess whether the company is in good legal standing and whether there are items that could present risk to the buyer. Key areas a buyer might investigate are:
- Corporate Structure
Your company’s corporate structure, capitalization, organizational documents, and general corporate records.
- Taxes
Historical income tax liabilities and any tax carry forwards and their potential benefits.
- Intellectual Property
The company’s technology and intellectual property, as well as its protection.
- Assets & Liabilities
The value of the assets that will be transferred with the sale, whether tangible or intangible, as well as all debts and liabilities against them.
- Contracts
Contracts and commitments of the company.
- Compliance & Litigation
Any pending, threatened, or settled litigation, arbitration, or regulatory proceedings and whether your company has faced any regulatory or compliance issues.
Financial
The buyer will conduct financial due diligence to verify that financial statements presented are accurate, and to gain a clear understanding of items that could impact the future financial performance of the company. For larger acquisitions, a CPA or other third party may prepare a Quality of Earnings (QoE) report to detail the components of the company’s revenue and expenses. The extent of financial diligence performed, and the quality of information available will vary considerably with the size of the business.
Business Operations
The purpose of business operations due diligence is for the buyer to gain an understanding of the company’s people, assets, technology, and processes. For online businesses, some of the most important assets are often the business’ sources of traffic, its platform and reputation.
Market
Market due diligence is unlike other aspects of due diligence in that information is gathered from outside of the company rather than from within. However, you may be able to assist the buyer in their assessment by providing reports, contacts, and other resources to help provide them with a more comprehensive understanding of the opportunities and threats in the space.
The extent and duration of due diligence can vary widely based on the size and type of transaction, lasting anywhere from a few weeks to three months or more. The time frame can be shortened when the information requested is available and organized, so upfront preparation can be helpful.
Closing Documents
As the buyer conducts due diligence, they will often prepare an initial draft of closing documents for your review. Depending on the complexity and size of the transaction, a purchase agreement can be very simple or very complex. While a simple transfer of a digital asset may only require a bill of sale, the acquisition of an income-producing business is typically accompanied by an Asset Purchase Agreement (APA) or Stock Purchase Agreement (SPA). Most acquisitions are asset purchases, meaning that the buyer transfers the tangible and intangible items owned by the business from the seller’s corporate entity into a different corporate entity owned by the buyer. These items generally include everything from the website, customers, and inventory to trademarks, patents, and goodwill. By contrast, in a stock purchase, the buyer acquires the seller’s business entity itself, which includes all of the assets and liabilities contained within. In either case, you will want to work with an M&A attorney to review the buyer’s proposed draft.
Asset Purchase Agreement (APA)
The key elements of an APA include a complete list of the assets being purchased (and not being purchased), liabilities assumed, the purchase price and how it will be paid and allocated for tax purposes, details on the closing and post-closing adjustments, seller and buyer representations and warranties, and the handling of disagreements post-transaction. There are typically schedules attached to the APA, including financials, organizational documents, contracts, permits and other key items upon which the purchase decision was based. Lastly, there are often separate agreements simultaneously signed at closing that handle elements of the transaction that fall outside of the APA, such as non-compete or consulting agreements.
Stock Purchase Agreement (SPA)
In a stock transaction, the buyer purchases the stock of the company from you, rather than its company’s assets. In doing so, the buyer assumes title of all assets and liabilities. While many of the provisions, schedules, and ancillary documents of an SPA are similar to an APA, the document itself is often simpler, since it does not need to delineate the specific elements of the purchase, or provide as much protection to the buyer around assumed liabilities.
While buyers tend to prefer asset purchases, sellers generally prefer stock sales. Asset purchases are less risky for a buyer in that they will not assume uncertain liabilities. Additionally, asset values can be determined as part of the purchase and the re-depreciated, to reduce taxes after the transaction. Stock sales are generally more favorable to the seller from a tax perspective, and they allow for a cleaner break from the business.
Transition
You will need to work closely with your team and the buyer’s team to transition the business through due diligence and after. Most importantly, you will need to inform and transition stakeholders, minimizing disruption to the business. These include employees, customers, suppliers, and dealers. Other elements requiring attention include the following:
- Computer, software, and website usernames and passwords
- Operating manuals
- Stakeholder contact information
- Vendor contact information
- Alarm codes, safe combination, keys
Quick Answer takeaways:
- Be transparent about any legal or other issues the buyer may raise.
- Have your attorney review the buyer's proposed draft of the purchase agreement.
- Write up a complete list of the operational things that need to get done before the closing.
We hope you took away a few insights that will help you successfully complete a business transaction. Feel free to browse businesses for sale in our deal directory or download our buyer's guide. Email us with any comments, suggestions, or insights of your own.
Images from Pixabay
