Getting through a buyer’s due diligence: what they will ask for and how to answer

Once a letter of intent is signed, the buyer starts looking inside your business. BDC, writing for buyers, describes due diligence as the research and analysis done in preparation for a business transaction, and says it gives the buyer access to the premises, records and, in some cases, key suppliers, customers and employees. This guide takes the seller’s side of that process: what the review covers, how to prepare, how to release information in stages, and how to keep a record of what was asked and answered. Deavo’s checklists cover the folder set-up and the disclosure list; this guide is about running the review itself.

What the buyer’s review covers

BDC sets out due diligence in three parts: financial, legal and commercial. For the financial part, it lists accountant-prepared year-end financial statements, bank statements, revenue by customer, and receivables, payables and inventory aging, and it says a buyer should check whether tax returns match the financial statements. For the legal part, it lists corporate documents such as certificates of incorporation, by-laws and shareholder agreements, employment contracts, licences and permits, past lawsuits, and real estate and intellectual property issues. The commercial part looks at how the business makes money, its competitive environment, and risks such as customer concentration. A buyer may order the work differently, so ask for its request list and its planned sequence.

Tax and records come first in your own preparation

Gaps in tax and accounting records are the easiest to find before a buyer does. The CRA says that, generally, required records and supporting documents must be kept for six years from the end of the last tax year they relate to. It also says records on long-term acquisitions and disposals of property, the share registry, or other historical information that would have an effect on the sale, liquidation or wind-up of the business must be kept indefinitely. Ask your accountant to compare your file against that list, including GST/HST and payroll records if they apply to you, and to tell you what is missing.

Prepare answers, not only documents

BDC advises sellers to spend time with their accountant and lawyer so that records are clean, up to date, and properly signed and completed. It also says it helps to anticipate potential questions: if you have a few key customers, be prepared to address the buyer’s concerns, and if you have key employees, be ready for the buyer to ask to meet them. Write a short answer to each question you can foresee, attach the document that supports it, and decide who may speak to staff and customers, and when. Ask your lawyer to confirm that plan before anyone is approached.

Staging personal information

Employee files and customer lists contain personal information. Under PIPEDA s.7.2(1), in addition to the circumstances in s.7(2) and (3), parties to a prospective business transaction may use and disclose personal information without the individual’s knowledge or consent if two conditions are met. First, an agreement requires the organization receiving it to use and disclose it solely for purposes related to the transaction, to protect it with safeguards appropriate to its sensitivity, and, if the transaction does not proceed, to return or destroy it within a reasonable time. Second, the information is necessary to decide whether to proceed and, if so, to complete the deal. Section 7.2(4) excludes a transaction whose primary purpose or result is the purchase, sale or other acquisition, disposition or lease of personal information. The Privacy Commissioner’s guidance says health and financial information would generally be considered sensitive. Ask your lawyer whether a summary will do early on, with names and details released later and only where necessary.

Staging competitively sensitive information

If the buyer competes with you, ask your lawyer before releasing information such as costs, prices and marketing plans. The Competition Bureau’s Competitor Collaboration Guidelines give costs, prices to be charged and marketing strategies as examples of competitively sensitive information. On information exchanges between competitors, they say that disclosing future pricing or future marketing activities is more likely to raise concerns than disclosing activities that took place in the past, such as historical costs or sales, though historical information can raise concerns where it provides a meaningful indication of future intended pricing or other competitively significant factors. The same guidelines say a proposed or completed acquisition of control over, or a significant interest in, the whole or part of a business will generally be assessed under the merger provisions, not the civil agreements or conspiracy provisions; where parties enter into an agreement that goes beyond the acquisition agreement, the Bureau will consider which provisions apply. They also encourage parties unsure how an agreement will be assessed to contact the Bureau at the earliest opportunity. They are not a guide to due diligence, so ask your lawyer what may be released, when, and to whom.

Keep a question log

A log lets you answer the same question the same way each time and shows what has been handed over. The data room checklist covers access controls; the log covers the conversation. Route every request through one person. A sensible log records:

• The date of each question, who asked it and which part of the review it belongs to
• Who on your side answered, the date, and the exact documents released with the answer
• Any answer given by phone or in a meeting, written up and sent afterwards so there is a record
• Items you could not answer or declined to release, with the reason, for your lawyer to review
• Anything the answers changed, such as a correction to an earlier figure or a new document

Ask your lawyer how the answers in the log relate to the statements you will be asked to make in the purchase agreement, and whether anything you have learned since should be added to your disclosure list.

Keep the business running

The review adds work on top of the day job. Check who will gather documents so the people running operations are not pulled away, and keep your books current, since BDC tells buyers to check whether the figures match what the owner tells them and whether tax returns match the financial statements, and says it is important to know how the business is trending. Confirm with your lawyer whether the LOI or confidentiality agreement limits what you may change while the review runs. For timing, see how long due diligence takes and the data room preparation checklist.