Why does due diligence beat up deals?
SHORT ANSWER
Timing and leverage. Most letters of intent include exclusivity, so by the time the buyer starts checking your business, you have no other buyers to turn to. Every issue the buyer finds becomes a reason to renegotiate, and you have less power to say no.
A price reduction during exclusivity is called a re-trade. It is the structural weak point of almost every sale process.
What do buyers find that lowers the price?
SHORT ANSWER
The most common triggers are business performance slipping during the sale, add-backs that don't hold up, working capital that wasn't agreed in advance, problems the seller knew about but didn't disclose, and customer concentration that's worse than presented.
- Performance slipping.Running a sale is time-consuming. If sales dip while you are distracted, the buyer will price it in.
- Add-backs that don't survive.The buyer's accountants trace every adjustment to a document. Anything unsupported gets removed, and the price falls with it.
- Working capital surprises.If the method for measuring working capital at closing wasn't agreed up front, it becomes a fight, and usually a price cut.
- Undisclosed problems.An issue you knew about and didn't mention costs more than the issue itself, because the buyer starts doubting everything else you've said.
- Customer concentration.When a few customers turn out to make up more of revenue than presented, the buyer sees more risk.
It isn't only the price that changes
SHORT ANSWER
Buyers often keep the headline price and change the terms instead. Watch for larger holdbacks or escrow, part of the price moved into an earn-out, special indemnities for specific issues, longer non-competes, and extended exclusivity.
These changes can cost as much as a price cut, and they are easy to underestimate because the headline number stays the same.
How do you prevent problems in due diligence?
SHORT ANSWER
Do the buyer's work before the buyer does. Review your own business the way a buyer will, fix what you can, document what you can't, and disclose it early. Then agree key terms, like working capital, in the letter of intent.
| Common problem | What it costs in diligence | Fix before going to market |
|---|---|---|
| Revenue doesn't tie to bank deposits | Buyer doubts all the numbers | Reconcile revenue to deposits for every year presented |
| Unsupported add-backs | Price drops by the add-back times the multiple | Document each add-back with an invoice or statement |
| No revenue-by-customer report | Concentration questions, delays | Build monthly revenue by customer from source |
| Working capital method not agreed | Price cut at closing | Prepare a 12-month schedule and agree the method in the LOI |
| Contracts with change-of-control clauses | Customers can walk after the sale | List them and plan consents early |
| Shareholder loans or tax filings behind | Special indemnities, holdbacks | Repay loans and bring filings current |
| Business depends on the owner | Lower price, longer transition | Delegate relationships and document systems |
Consider a sell-side quality of earnings review
A quality of earnings review is an accountant's test of whether your earnings are real. Buyers almost always run one. Commissioning your own before going to market turns surprises into known facts you can explain on your terms.
Front-load the bad news
Your disclosure schedule lists exceptions to the promises you make in the purchase agreement. Anything properly disclosed generally can't be claimed as a breach later. Disclosing difficult issues early, and explaining them, is far cheaper than having a buyer discover them.
Keep exclusivity short
The shorter the exclusivity period, the less time a buyer has to wear you down. Pair it with a well-organized data room so the buyer can move quickly.
Keep running the business
SHORT ANSWER
The best protection in due diligence is a business that keeps performing. That's easiest when a management team handles day-to-day operations while you handle the sale.
For the full timeline, see How to Sell a Business in Canada: The 12-Month Playbook.