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Due Diligence

Jan 3, 2022

Tim Schuster is joined by Lisë Stewart and Alan Wink discussing the all-important aspect of selling a business: due diligence. Our experts weigh in on this process, which can be long and tedious for the seller.


tim schuster: Hello, and welcome to The Bottom Line. This podcast examines the everyday business and finance issues faced by closely held and private businesses. We hope to provide you with news you can use, and what we like to think of as a jargon free zone. I'm your host, Tim Schuster, Senior Manager in Private Business Services. And with us today is Lisë Stewart, Partner in charge of Center for Individual and Organization Performance, and Alan Wink, Managing Director of Capital Markets. This is part of a series of podcasts on selling a business, and this topic is all about due diligence, which I'm sure is everyone's favorite, favorite, favorite subject. Lisë, Alan, great for you to be here.

lisë stewart: Thanks, Tim. It's really nice to see you.
alan wink: Tim, good to see you again.

tS: Good to see you guys too. So, let's just dive right into it. Can you explain what due diligence is?
AW: It's probably the part of the transaction that sellers have the most difficult time with. Because it's the time now that an LOI has been signed, you know what the broad terms of the deal are going to be. Now, the buyer has the opportunity and responsibility to verify that all the information that was presented to them about the company, financial information, legal information, operational information is true. Most deals are priced at a multiple of EBITDA, earnings before interest, taxes, depreciation, and amortization. And so, if the EBITDA in a deal is, let's just say $10 million and it's priced at seven times that, it's a $70 million deal.

When you go through due diligence and the buyer finds a number of things that were misrepresented by the seller or issues with their financial performance and their adjustments to EBITDA, that automatically usually results in a adjustment to the purchase price. So, if it's a seven X multiple, every dollar of change results in a $7 reduction in the purchase price. So, sellers have this obligation to ensure that the data room, and most data rooms now are virtual and online, are populated with a bunch of information. And it takes quite a long time to populate that data room with your historical financial results, contracts, et cetera.

And most buyers will hire an accounting firm to do a due diligence review, a quality of earnings review, to make sure that the revenues and the earnings are sustainable going forward. And that's a long process. So, when you think about the sale process, buyer and seller sign a letter of intent, which is a non-binding document. The buyer embarks upon 60 to 90 days of due diligence, usually a period of time where they have a level of exclusivity. And at the same time, they're negotiating the definitive agreements. And then you have these discussions around the findings of due diligence and what impact that might have on the eventual purchase price. But due diligence is a long arduous process for any seller.
LS: Yeah. I was meeting not too long ago with a little investment firm that was looking to inquire a manufacturer, and they told me that they're stepping away from the deal. They're not going to do it. And when I asked them questions why, the gentleman said, "I had a bad feeling. I just had a bad feeling about the seller, because it felt like he wasn't always telling the straight story, like he was just trying to fudge along the edges. It felt like he was making some stuff up and he was trying to make a really big deal of these potential contracts and so on." So, I think what's really important there is that the due diligence process is an opportunity to build trust. And you want to buy business, you want to invest in businesses where that trust is really high.

So, I think one of the most important factors is don't give your potential buyer anything to feel uncomfortable about in this process. Don't erode trust by just fudging the data. Be honest, be thorough, be transparent, be thoughtful about this. People want to do business with people that they can respect, that they believe have integrity, and that they can trust. And that's really about to be the foundation of the entire due diligence process.

By the same token, I have known sellers that have walked away from the deal because they felt like they couldn't trust the potential buyer. So, our interpersonal characteristics, I think, are just as important as our financial documented materials and it's got to be a two way street. Trust is transactional. Both parties have to trust each other.
AW: And Tim, I would just add to that because I always advise our clients that due diligence is a two-way street. And as much due diligence as a buyer does on a seller, a seller should be doing similar due diligence on a buyer. And part of that due diligence from a seller's perspective is making sure the buyer has the financial wherewithal to do the deal. Where's the money coming from? I'm involved in a transaction right now, where we spent a lot of time negotiating LOI. And in this particular instance, the seller would not give the buyer exclusivity during the due diligence process, unless the buyer was able to show specifically where the capital was going to come from to complete the transaction. And so, we had to get term sheets from lenders and we had to show them the balance sheet of the buyer and showing them the working capital liquidity was there to do a deal. And so, it's really important to do due diligence on both sides.
LS:Yeah, I would agree with that too. And just one other thing, because I know that you and I have talked a lot about the importance of surrounding yourself with good advisors. We have to be able to trust those advisors too, on both sides of the table. And so, I think, sometimes, what happens is that you'll bring an advisor in, maybe you don't know that person that well, and they start to be a little less transparent or they seem just a little bit shady. So, everybody has to be working together to build that trust. Make sure that the advisors who are representing you maintain the same level of integrity that you would maintain in that deal. And you'll be looking at the advisors on the other side of the table and looking for that as well. So, I think all of these elements are just really key to making this successful.
tS: Lisë, I'm glad you said that, because that was going to be my actual next question, which you eloquently answered already, which is perfect because it is important to have the right team there, just in place. And that's something that I think a lot of people sometimes don't consider because you really want to make sure you have the correct representation there for your matters. So, now, let's say hypothetically, your team's in place, everything's good to go, due diligence is going on, and it seems to be going swimmingly. What is actually the next step in the process after due diligence for a business owner to consider?
AW: Well, usually, Tim, while due diligence is going on, either the buy side or the sell side, the lawyer representing the company will begin the process of drafting the definitive agreement and all the reps and warranties that the sellers are going to be responsible for. So, as due diligence is finishing up, hopefully, the definitive agreement will also be reviewed by both sides and be ready to be signed. And then, probably the last issue is one of the working capital adjustment. How much working capital does the seller have to leave in the business for the buyer? And that's usually something that's resolved by closing. There's usually a post closing adjustment, either up or down in terms of what the final balance sheets look like.

But usually, the seller is going to try to take as much cash off the balance sheet as they possibly can. The seller like more cash, more working capital remain in the business. So, there's got to be a meeting in the minds in terms of what is the appropriate amount of working capital that should remain with the buyer after the deals closes.
LS:I think that also speaks, Alan, to the fact that you're going to be leaving a company behind and often it's going to be that management team that you built. And they're going to have some concerns about are you leaving a stable company, who's going to be taking this over, and so on. I know that some of the key questions that we get as companies start to move more through these formal, the due diligence procedures is, who in the business should we tell? A lot of times you've got your CFO, who's going to be involved in the transaction. You might have somebody on operations who could be involved and you're trying to manage those sorts of relationships. So, as you're doing this and working your way through the transaction, trying to make sure that those people are kept informed to the level in which you can inform them, let them know what this is going to look like.

I know that they're going to be wondering about is the capital being left in the company enough to be able to make sure that my job is going to be secure for the future and so on. And then later on, as you begin to, hopefully, put a bow around this transaction, you're going to also need to think about your communication plan. How are you going to roll this out? How are you going to put together a plan that's going to cover your customers, any other stakeholders, and of course, all of your employees?

So, there's a dual process that's going on as you're starting to consider this. Because once that transaction hits, you don't have the luxury of time to be able to get all this stuff put together. You've got to be thinking about this as it's really starting to all fold together.
AW: As Lisë actually said, you have to determine who are the key people in your organization. And those people are probably going to be very important both during due diligence and in any transition. And a lot of business owners will try to negotiate into the deal, contracts for their key employees. Certain business owners will offer, if they know that their employees will not be offered positions after the deal closes, they might offer those people stay bonuses to stay until the end of a transaction because they're so critical and they'll get a nice chunk of money if they do stay. Dealing with your key employees is very important. There's not just one single solution, there's a couple of possible solutions. But people become very important in these deals, in terms of getting them done and moving it on to a new entity.
tS: Absolutely. And listen, Lisë, Alan, can't thank you enough again for being on The Bottom Line series and sharing this valuable information to our listeners. And thank you for listening to The Bottom Line, part of the EisnerAmper podcast series. Visit for more information on this in a host of other topics. And join us for our next podcast, where we will cover how much you get to keep after a sale.

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