Financial Due Diligence (When Selling a Business)

When selling your business – or any of its parts – lenders and investors will require a review of your financial health. This is known as Financial Due Diligence (FDD).

Understanding the importance of financial due diligence is essential for both sellers and buyers, as it is extremely useful for validating financial health, uncovering hidden risks, and ensuring a smooth transition overall.

As a seller, you might feel anxious about the process, but financial due diligence is an integral part of buying and selling. This blog will break down what financial due diligence is and why it is important.

What is Financial Due Diligence?

Financial due diligence (FDD) is an independent investigation into a company’s financial health, conducted during the sale process.

The ICAEW says that FDD identifies potential financial risks and hidden liabilities that could affect the final purchase price or the long-term viability of the acquisition.

Financial Due Diligence performed by the Seller on their own business aims to address any concerns and issues that may be relevant to the buyer, both early on and in the future.

Rather than waiting for a buyer to discover potential issues, identifying them yourself first builds trust and credibility. If you’re proactive with having your business assessed, you can identify risks early and streamline the selling process.

When reviewing your FDD, lenders and investors will want to know whether the reported figures reflect the business's underlying performance, and therefore its true long-term value. A robust FDD process will provide evidence of this and help identify issues that need to be resolved.

What does Financial Due Diligence aim to do?

A financial due diligence report will aim to identify and help you resolve a variety of potential issues that could undermine a sale, including:

Identifying potential red flags relating to debt, cash flow, and tax liabilities
Assessing the sustainability of historical profits
Understanding the normal level of working capital needed to run the business
Making sure the company valuation matches its true market value
Reviewing how sensitive elements of the financial performance are

Why is Financial Due Diligence So Important?

As mentioned, it is important to identify and fix any issues before buyers do because this will accelerate the sale process and maximise deal value. This simultaneously builds trust and credibility between the seller and the buyer, which is a very important part of selling.

How to Prepare for Financial Due Diligence

Taking a proactive approach to financial due diligence is key to a smooth and successful sale process. To prepare, make sure you consider the following steps:

Assess and summarise normalised earnings
Tidy up the financial statements. Buyers often want to see at least 3 years of good quality management information
Build a robust data room ready to deploy
Test your working capital position and understand a normalised position
Ensure the management information also has a narrative built around it- this is key when the questions come

Common Issues during Financial Due Diligence

If issues do arise, don’t be alarmed. It is not uncommon for a business to encounter issues during the due diligence process – that is what it is for!

The benefit of seller financial due diligence is that you identify potential problems before the buyer's financial due diligence, when you are ready to sell, allowing you to address any problems well in advance.

Common issues include:

Revenue recognition
Assessment of "normalised earnings"
Accounting and control weaknesses
Forecast credibility
Profit to cashflow reconciliation
Large errors in the financial statements
Inadequate reporting structure suitable for buyer FDD
A variety of potential tax issues

When else is Financial Due Diligence needed?

Financial Due Diligence is a key part of the process of selling a business, but it is also essential when seeking investment via venture capital or private equity investors. It will also be involved in transactions like a Management Buyout (MBO), or with joint ventures or partnerships.

Contact us if you need assistance with FDD

A high-quality due diligence report goes further than presenting numbers.

It provides a detailed, clear, and decision-ready view of a company’s financial position and tax risk profile. If your FDD report is easy to follow and invites scrutiny and adjustment without friction, it will be efficient.

Financial due diligence is a crucial part of selling your business (or its parts). Understanding exactly what it is and how taking a proactive approach is especially important.