How to Prepare for Legal Due Diligence When Selling Your Business

Sooner or later, M&A will recover from COVID-19, and the recovery may come earlier than some analysts anticipate. If you are planning to sell your business or raise capital, preparation is key. One of the most important things to prepare for is legal due diligence. Here’s what you must know to be ready. 

What is Legal Due Diligence? 

During legal due diligence, a prospective investor reviews legal records associated with the company, including governing documents, holdings, contracts with suppliers and clients, transactional documents, and IP agreements. Prepare for this ahead of time, because it can be intense. 

At the very least, well-organized legal documents can make a favorable impression that make negotiations smoother and ensure timely closing. It can also help you promptly respond to requests by investors. 

Make Sure Governing Documents Reflect Operations 

Potential investors will want to see the governing documents to ensure that the business is conducted in accordance with these documents. So you must review governing documents and other agreements to ensure they accurately reflect economic relationships. For example, IP contracts should be between the company and another party, not between individual employees or owners and the IP owner. If your current documents are absent or unreflective of reality, consult with an attorney about amending them. 

Update Supplier and Customer Agreements 

While you may feel confident in your business’s relationship with suppliers and customers, prospective investors and buyers want an independent understanding of those relationships, and usually want them memorialized in formal contracts that outline specific conditions and terms. Make sure these agreements are current, especially when those agreements involve intellectual property. 

Ensure All Transactions Are Documented in Writing

Small and closely held corporations often enter into transactions with owners’ friends and family. These transactions may be secured with little more than a handshake, even when lots of money hangs in the balance. If you anticipate a sale, make sure these agreements are clearly memorialized. Buyers must understand the terms of these arrangements, and be able to assess whether these agreements will continue if a new owner takes the reins. 

General Recommendations 

Buyers do not like risk, and they abhor uncertainty. Informal agreements present a lot of both. This is a completely controllable aspect of due diligence, and something you can do now to reduce the risk to the buyer and present your company as a professionally run machine. 

In general, all agreements should be formalized into a written document, even if the agreement is of low value or is with someone you trust. So as you move closer to a sale, work with a lawyer to review these agreements and formalize them as necessary. The more work you do now, the less you will have to take on as you approach closing. Moreover, you’ll present the buyer with less work, offering them a business that is already well-run with agreements and processes clearly outlined and formalized in binding agreements that protect all parties. That’s a strong selling point that can raise value.