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Preparing to sell: the buyer looks where you stopped looking

An owner getting ready to sell usually prepares the story: the numbers, the growth, the reason somebody should want this. The buyer’s advisers read the paperwork instead, in the parts of the business the owner stopped examining.

Due diligence is an inspection by people with no shared history with the business and no memory of why anything was done the way it was, which is exactly what makes it effective. An owner passes over an agreement that was never signed, or an arrangement everyone treated as settled, because they know what was meant by it. A reader without that context sees only what the document says, and where there is no document, sees the gap.

Sellers brace for the dramatic finding: the claim, the aggrieved former director, the customer threatening to leave. Those rarely do the damage, because they are visible and both sides can value them. Price is more often taken apart by an accumulation of unremarkable things, never wrong enough to demand attention on any ordinary trading day. Preparation is a matter of reducing the number of open questions somebody else gets to price.

The buyer reads the file

A business that has traded successfully accumulates arrangements that work without being written down properly: the supplier who has never let anyone down, the customer whose orders arrive without anyone rereading the terms they arrive under. The owner experiences that as stability. A buyer sees relationships the other party can end at will, and prices the possibility that they will.

A second asymmetry costs more than sellers expect. The seller answers questions from memory; the buyer checks the answers against the file. Where the two do not match, the harm is not confined to that item. An adviser who finds one confident answer wrong stops treating the rest as reliable and widens the enquiry, and a widened enquiry always finds more.

The particular sensitivity in a sale is continuity. Much of what is being bought is the expectation that revenue survives the change of owner, and continuity is what the contracts govern. Agreements letting a counterparty walk away, or requiring their consent, when control of the company changes hands turn a revenue line into a question whose answer belongs to somebody outside the deal. Those provisions sit in customer contracts, leases, funding documents and technology licences, and are read by nobody until the moment they matter.

The problems that reduce the price are dull

The items that recur are not scandals, but what a business looks like when it has been busy.

• The most important customer has never signed anything. The relationship runs on orders, invoices and mutual goodwill, which means it runs on the customer’s standard terms rather than yours, and can be stopped at will.
• The premises are occupied on a basis nobody has examined since the move. A lease whose term expired while the business carried on paying rent, or a property held by a related party under an understanding rather than a document, is a question no buyer leaves alone.
• Someone described as a contractor looks like an employee. A person who has worked for the business alone, under its direction and on its systems, raises questions of status carrying consequences for tax and employment rights, and buyers treat those as liabilities rather than opinions.
• Something the business trades on is registered to an individual. A buyer expects everything the company depends on to belong to the company, and moving it across requires the co-operation of whoever holds it, given at a stage when its value to the transaction is obvious to both sides.
• Company records do not match what actually happened. Share transfers agreed and never documented, options promised in conversation, and board decisions taken without being minuted all create uncertainty about who owns what, which attaches to the shares being sold.

Individually, an owner can explain each of these in a sentence. Collected into a report for an investment committee or a lender, they stop being explanations and read as a pattern, and the buyer’s advisers cannot responsibly recommend that a pattern be ignored. They are obliged to propose protection, and protection has a price the seller pays.

How an open item becomes the seller’s money

The mechanism is the warranties and indemnities in the sale agreement. A warranty is a statement of fact about the business that the seller gives and stands behind: that the company owns its assets, that it complies with its contracts, that no dispute of a given kind exists. If a warranty proves untrue, the buyer may claim under the contract, broadly for the difference between what the business was worth as described and what it was actually worth, subject to the limits on amount and time the agreement sets. An indemnity is different: a promise to reimburse the buyer for a specified matter, drafted to avoid arguments about how loss is measured. It is how a known problem is handed back to the seller in cash.

The seller’s protection against the warranties is disclosure. Under the law of England and Wales, as these agreements are ordinarily drafted, an issue properly and fairly disclosed before signing generally cannot found a warranty claim afterwards. That sounds like an escape and is not, because disclosure and pricing are the same conversation. Every unresolved item therefore reduces to a choice among three: repair it before anyone asks, disclose it and accept an adjustment to the price or a sum held back from it, or say nothing and carry the risk into an agreement you have signed personally.

The part sellers grasp last is what happens after completion, when liability continues and control does not. The buyer owns the company, holds the records, employs the people who remember what was done, and decides how the underlying matter is handled: whether to contest an assessment from HMRC or settle it, whether to fight a former employee’s claim or pay to make it go away. A seller who has given an indemnity is funding decisions taken by somebody with limited reason to keep the bill small. Where part of the price is held back as security, the seller has financed the buyer’s protection out of their own consideration.

Sale agreements can address this. How claims are notified, who conducts a dispute that triggers an indemnity, what the buyer must do before conceding anything: these are negotiated positions, and they are settled at the end of a process, when everybody is tired and the seller has been told the deal is nearly done.

The same repair costs more once a buyer is watching

A problem left open is not discounted at what it would have cost to repair. If it touches earnings, because a customer might leave or a cost is higher than the accounts assume, it is discounted against the multiple being paid for those earnings, so a recurring exposure is deducted against the multiple rather than at its annual cost. If it is an uncertain liability, it is valued at the cautious end of what it might be, because caution is the only defensible thing to put in writing to one’s own client.

Repairs made under observation announce themselves, because documents carry dates. A remedial agreement signed while diligence is running tells the reader when the problem was noticed, and invites the obvious question about the period before it, which is the period the buyer is being asked to inherit. Third parties are the other constraint, and there the difficulty is usually timing rather than price. A landlord asked to consent, a funder asked to waive, a counterparty asked to confirm something in writing: none of them work to a completion date, and a transaction waiting on a signature loses momentum.

There is also the point at which the seller’s position quietly changes. Heads of terms commonly carry a period of exclusivity, during which the seller agrees not to talk to anybody else. That is reasonable, since the buyer is about to spend real money investigating. It also means everything discovered from then on is discussed with a seller who has nowhere else to go, has told their staff or their family, and has begun to think of the sale as something that is happening. Owners renegotiate badly from inside that position.

What is not worth doing

A full preparation exercise is the wrong use of money where a sale is an idea, not an intention. If nobody has decided anything, keep the obvious housekeeping current and leave the rest. Perfect paperwork is not the objective, and no buyer expects it.

Some items are better left. Something immaterial to what is being bought does not repay the effort. Something whose repair means opening a conversation with a counterparty who is presently content, and who would want a fee or a concession to put their name to anything, may be better left as it stands and dealt with by disclosure. Restructuring so the business looks neater is its own hazard, because moving assets and companies about carries tax and contractual consequences worse than the untidiness being cured.

A caution applies to the exercise itself, and it is why reviewing your own business is not a free good. Looking creates a record, and it creates knowledge. A seller who did not know of a problem and one who knew and said nothing are not in the same position when the warranties are tested, and the limits a sale agreement places on claims tend not to protect a seller who has been dishonest. Finding out what is in your business is only useful alongside a proper decision about each thing found.

Sorting items into those three categories, repair, disclose, or leave, is the whole of the work, and it is the part an owner is least equipped to do about their own business. The judgement turns on how a particular buyer, in a particular market, with particular advisers and a particular reason for buying, reads what is in front of them. The items most often placed in the wrong category are the ones the owner has lived with longest and stopped noticing.

This guide is general information about how these matters usually run. It is not advice, and nothing becomes advice until terms are agreed in writing. Brandleys Legal Ltd delivers reserved legal activities alongside regulated partners.