When it is time to sell your business, conducting sell-side due diligence before going to market is essential to maximizing the outcome. While many business owners are familiar with due diligence from the buyer’s perspective, fewer realize the value of preparing their business for the same level of examination before a sale. Proactive sell-side due diligence can lead to a smoother sale process, better valuation, and fewer unexpected issues along the way.
What Is Due Diligence?
Due diligence is the process of identifying and assessing a company’s value by conducting a deep dive into its financial, operational, legal, and regulatory information. It is typically performed during a merger and acquisition (M&A) transaction to help a buyer evaluate the business and identify any risks or potential opportunities.
The process is rigorous and often involves a multidisciplinary team of specialists to provide a comprehensive review of the business. This includes gathering key documents, reports, and other relevant data—then analyzing them for completeness, accuracy, and compliance. The purpose of this review is to ensure the information presents a full and accurate picture of the company and aligns with established accounting standards—such as Generally Accepted Accounting Principles (GAAP), the framework of rules and guidelines used in the U.S. to prepare and present financial statements—as well as applicable regulations and internal company policies.
Understanding Sell-Side Due Diligence and Why It Matters
While the potential buyer typically performs due diligence, sell-side due diligence is when a business owner proactively conducts this review before the buyer enters the picture and the sale process begins.
Conducting sell-side due diligence provides several advantages:
Better understanding of your business. Reviewing your records helps you see your company the way a buyer will—and allows you to better present your value during the sale process.
Fewer surprises. Identifying and addressing existing issues ahead of time—before they’re uncovered during the buyer’s due diligence—often allows for an opportunity to correct issues and reduce friction during the process, thereby building buyer confidence.
Stronger financial presentation. Sell-side due diligence helps support accurate calculations of key financial measures, such as normalized earnings before interest, taxes, depreciation and amortization (EBITDA) or seller’s discretionary earnings (SDE). These metrics help buyers evaluate the business’s core profitability and compare it to other opportunities—factors that can directly influence the sale price.
Smoother process and more preparation time. A significant volume of information is required or requested by buyers during the M&A process and the buyer’s due diligence. Preparing early gives you time to ensure documents are complete, accurate, and consistent. It also helps you stay ahead of the buyer’s information requests, reducing last-minute scrambling and potential delays in the deal.
What to Review in Sell-Side Due Diligence
Key areas to focus on during sell-side due diligence include corporate records, financial reporting, accounting policies, and tax documentation. However, a comprehensive review extends beyond financials to encompass operational, legal, human resources, and IT aspects, all of which can significantly impact your business’s attractiveness and value.
Corporate documents. Start by confirming that your corporate records are complete and up to date. This includes your articles of incorporation or organization, certificate of good standing, and a current organizational chart outlining the company’s structure. Ensure all corporate minutes, shareholder agreements, and any intellectual property registrations are also readily accessible and accurate.
Financial records. Assemble at least three years of financial information, including year-end statements—such as audits, reviews, or compilations. Monthly profit and loss (P&L) reports, balance sheets, and cash flow statements should also be included. These monthly statements should be analyzed for trends over time, and any anomalies should be identified, explained, and adjusted as needed. Create supporting schedules to back up reported figures and help buyers validate the accuracy of the financials.
You’ll also need to calculate your SDE, which is a cash-flow-based measure of earnings. SDE begins with pre-tax income and is adjusted for several factors, including non-cash expenses (e.g., depreciation and amortization), normalized owner compensation and benefits, and discretionary spending (such as owner perks or charitable contributions), one-time or non-recurring expenses, discontinued operations, and any M&A-related costs. For larger businesses, especially those with established management teams and revenues typically exceeding $5 million, normalized EBITDA is often the preferred metric. This involves similar adjustments to EBITDA to remove the impact of non-recurring or non-operating items, providing a clearer picture of the company’s core operational profitability for a buyer not necessarily replacing the owner-operator.
Accounting policies. Document your company’s accounting policies clearly—especially your methods for revenue recognition and fixed asset capitalization. Outline your approach to managing receivables that are at risk of not being collected, including whether you use an allowance for doubtful accounts or write off bad debt; inventory valuation methods; expense recognition; and any significant accounting estimates.
These policies should align with GAAP and be consistently applied over time to support transparency and comparability.
Tax filings. Prepare to share all current tax elections, along with three years of tax filings. This includes federal, state, and local income tax returns, supporting workpapers, sales tax filings, and any other relevant tax documents, such as business occupation tax returns. You should also gather any correspondence related to tax audits or notices.
Buyers may also request information on your sales tax nexus—i.e., where your business has a tax obligation due to physical presence or economic activity in other states. For example, in New York, having employees, inventory, or regular sales in a locality may trigger state and local sales tax requirements. Be ready to document where you have established nexus and how those obligations are managed. It’s also crucial to review payroll tax compliance, any state or local tax incentives, and potential tax exposures.
Legal and Regulatory Compliance. Beyond corporate documents, prepare all material contracts, including customer agreements, vendor contracts, leases, and any loan agreements. Disclose any past or pending litigation, regulatory inquiries, or environmental compliance issues. Ensure all necessary licenses and permits are current and in good standing. Review and organize any intellectual property filings, trademarks, and patents. Addressing these areas proactively can prevent significant deal breakers.
Human Resources. Prepare an up-to-date employee organizational chart. Gather and review employee contracts, benefit plans, compensation structures, and any HR policies and procedures. Be prepared to provide details on key personnel, employee turnover rates, and any past or pending labor disputes. Summarize the company’s policy on using independent contractors and consolidate any related agreements. Proper HR documentation can demonstrate stability and a well-managed team.
Operations and IT. Consider documenting your key operational processes, supply chain details, and customer base. For IT, this should include documenting your systems, software licenses, data security protocols, and disaster recovery plans. A robust and secure IT infrastructure is increasingly important for business valuation.
Get Support for a Smoother Sale
If you’re planning to sell your business in the near future, sell-side due diligence can help you stay ahead of the process and protect your business value. At 1RDG, we work closely with business owners every day to prepare for successful exits. To learn more about how we can support your sale, reach out to 1RDG by calling 585-673-2600.