Most owners prepare for a sale by getting ready to answer questions. The better preparation is to remove them.
That is the whole idea behind sell-side diligence: you commission the examination of your own business, on your own timetable, before any buyer sees it. Whatever is found, you either fix it, document it, or decide how to present it — and you do all three while you still have leverage, rather than in week six of an exclusivity period when the only options left are a lower price or no deal.
This article sets out what sell-side diligence actually involves, which findings do most damage after heads of terms are signed, how to test your own numbers, contracts and records before a buyer does, and what an owner should fix in the year before going to market.
Buyer diligence is a verification exercise conducted by someone with an incentive to find problems. Sell-side diligence is the same examination, commissioned by the seller, with an incentive to find those problems first.
In practice it has three components. The financial piece is a quality of earnings review: an independent analysis of what the business actually earns, how repeatable it is, and which adjustments survive scrutiny. The legal and contractual piece is a health check on ownership, agreements, consents and liabilities. The operational piece is an honest assessment of how much of the business depends on the owner and on a handful of relationships.
It is not a valuation, and it is not marketing material. An information memorandum argues a case. Sell-side diligence tests one. The two documents serve different purposes and a buyer can tell immediately which one they are reading.
Scope should be proportionate. For a smaller business, a full vendor due diligence report is overkill; a scoped earnings review plus a legal health check is the right level. Advisers commonly quote sell-side earnings reviews in the region of twenty-five to fifty thousand for businesses in the lower middle market, and report that only around half of founder-led sellers commission one — which is precisely why doing it is an advantage rather than a formality.
Signing heads of terms feels like the finish line and is closer to the starting gun. Analyses of failed transactions consistently put earnings discrepancies found during diligence, and other diligence findings, among the largest single causes of collapse — not buyers disappearing, but businesses not holding up under examination.
Three categories do most of the damage.
The first is earnings quality: adjustments that cannot be evidenced, revenue recognised early, costs that turn out to be recurring after all, or monthly figures that do not reconcile to the annual accounts.
The second is contractual: change-of-control clauses nobody read, key agreements that were never signed, terms that expired years ago while trading continued regardless, or intellectual property created by contractors who never assigned it.
The third is undisclosed liability: tax positions taken years ago and never tested, employee classification, unpaid holiday accruals, environmental history, or a dispute the owner considered settled and the file does not.
Every one of these is discoverable in advance. That is the entire argument for sell-side diligence.
The single most valuable exercise is to have your adjusted earnings challenged by someone independent before a buyer's accountant does it.
A proper review does four things. It tests whether each add-back is genuinely non-recurring and evidenced, rather than asserted. It examines revenue recognition and cut-off, particularly where work spans period ends. It reconciles monthly management accounts to statutory accounts and to the bank, which is where inconsistent reporting shows up. And it separates the earnings that will exist after you leave from the earnings that exist because you are there.
Owners are routinely surprised by which adjustments fail. Personal expenses running through the business are the classic example: they are add-backs only if they can be identified, evidenced and shown to be genuinely personal, and a buyer's default assumption when the evidence is thin is that the cost is real. It is usually better to stop running them through the company a full year before the sale than to argue about them during it.
A supported earnings figure also changes the tone of the negotiation. When the seller's number has already been independently tested, the buyer's accountant is checking work rather than rebuilding it, and the discussion moves from "prove this" to "we agree, subject to". In our experience at Conclave Partners, that shift is worth more than any individual adjustment in dispute.
Diligence is as much a judgement about how a business is run as about what it earned. Reporting that only came into existence for the sale process is read exactly that way.
Monthly management accounts should exist for at least two years, be produced on a consistent basis, and reconcile. Accruals and cut-off should be handled the same way each month. Stock and work in progress should be counted and valued on a documented policy. Intercompany and director accounts should be cleared or explained. Related-party transactions should be identified before someone else identifies them.
None of this is glamorous, and all of it is read as a proxy for management quality. A buyer who finds tidy, consistent, reconciled records assumes competence elsewhere. A buyer who finds three different versions of last year's EBITDA assumes the opposite, and prices accordingly.
Working capital is where deals lose money quietly, after the headline price is agreed.
The mechanism is straightforward: the buyer pays the agreed price on the assumption that a normal level of working capital comes with the business. The argument is about what "normal" means. It is settled by reference to a monthly trend, usually twelve to twenty-four months, and whoever arrives with that analysis prepared has a large advantage.
Prepare it yourself. Show the monthly balances, explain the seasonality, define what is included, and take a documented position on the items that always cause argument: deferred revenue, customer deposits, accrued capital expenditure, overdue receivables, stock provisions, and anything the buyer may want to classify as debt-like rather than working capital.
Sellers who leave this to the buyer's model frequently discover that several months of profit have been redefined as a working capital shortfall. Sellers who bring their own analysis negotiate from data, and usually keep most of it.
Legal diligence rarely uncovers a catastrophe. It uncovers absence: the contract that was never signed, the term that lapsed, the clause nobody remembered.
Work through the material agreements and answer four questions for each. Is it signed and current? Does it contain a change-of-control or assignment clause, and if so, whose consent is needed? What are the notice periods and are they mutual? And does it contain anything unusual — exclusivity, most-favoured pricing, uncapped liability, automatic renewal on terms you would not accept today?
Then check what sits outside the contract file. Property leases and their assignment provisions. Licences and permits, and whether they attach to the entity, the premises or a named individual. Employment contracts, particularly for the people the buyer will care about, and whether restrictive covenants are enforceable in the relevant jurisdiction. Intellectual property, including anything created by contractors or freelancers, where an assignment clause may simply be missing. Data protection: what personal data you hold, on what basis, and what happens to it on a transfer.
Where consent will be needed, identify it early. Consents sit on the critical path and are the most common cause of a completion date moving.
The company's own records are the easiest thing to fix and one of the more common sources of delay.
Statutory registers, share register, option grants and their paperwork, board minutes for anything material, subsidiary structures including dormant ones, and any historic share transfers that were agreed informally and never documented. If ownership is unclear, nothing else can proceed.
On tax, the point is not to assume the worst but to know where the exposures are: historic treatment that was reasonable at the time but has never been tested, employment status of contractors, benefits and expenses policies, indirect tax treatment of anything unusual, and any open correspondence with the authorities. A known exposure can be quantified, disclosed and covered by an indemnity. An unknown one found in diligence becomes a reason to restructure the deal.
Owner dependency is the finding sellers most often dispute and buyers most consistently price.
Test it properly rather than assert an answer. Write down every decision made in the last three months that only you could have made. List the customers whose main relationship is with you personally. Identify the pricing, hiring and escalation decisions that route through you. Note how long the business has ever run without you being reachable.
Then fix what the list reveals, and let a year pass so the fix appears in the data rather than in a promise. Named relationship owners other than you. Documented pricing rules. A second signatory. A management meeting that happens whether or not you attend.
The same applies to concentration of a different kind: one supplier, one system nobody else understands, one contract manager holding the operational knowledge. Buyers underwrite what happens when that person or that dependency disappears.
Every business has issues. The question is when the buyer learns about them.
An issue disclosed at the outset is priced once, as part of the offer. The same issue discovered in diligence is priced twice: once for the issue itself, and once for the doubt it casts on everything else that has been said. The second charge is usually larger, and it is entirely avoidable.
The practical method is a known-issues schedule prepared before launch: what the issue is, its likely quantum, what has been done about it, and what protection is proposed. It feels counterintuitive to hand a buyer a list of problems. It works because it converts uncertainty into defined items, and because the seller who volunteers the difficult facts is believed on everything else.
Sellers who ask Conclave Partners where to start on preparation are pointed at the earnings review and the known-issues schedule, in that order, because between them they determine both the price and whether the price survives to completion.
The earnings review should be done by someone independent of the people who prepared the accounts. Your own accountant knows the business, which is useful, but they are also being asked to challenge their own work, and a buyer will discount the conclusions accordingly. A separate firm with transaction experience produces a report the other side treats as evidence rather than advocacy.
The legal health check is different: your existing lawyers are usually the right people, because the work is mostly a matter of collecting, checking and correcting documents they already know. What matters is that someone is asked the awkward questions — is this signed, is this current, whose consent do we need — rather than assuming the file is complete.
The one thing that should not be outsourced is the decision about what to fix and what to disclose. That is a commercial judgement about how each item will read to a specific type of buyer, and it depends on who you are likely to sell to. At Conclave Partners we take the diligence findings and sort them into three lists — fix now, fix if there is time, disclose and price — before any material is written, because a finding that matters enormously to a private equity buyer may be irrelevant to a trade acquirer, and the reverse is equally true.
Twelve months before launch, start the reporting discipline: consistent monthly accounts, cleared director and intercompany balances, personal costs out of the company, documented stock policy.
Nine months before, run the contract review and the corporate and tax health check, so that anything requiring a renewal, a consent or a correction has time to be dealt with rather than merely disclosed.
Six months before, commission the earnings review, once the reporting is clean enough for it to be worth doing. Running it too early produces a report on numbers you are about to change.
Three months before, assemble the data room from the diligence findings, prepare the known-issues schedule, and prepare the working capital analysis.
The point of the sequence is that preparation should produce fixes, not just disclosures. Work done twelve months out changes the accounts. Work done three weeks out changes only the wording.
A prepared seller runs a faster process. Diligence after heads of terms typically takes several months in lower middle market transactions, and most of that time is spent producing documents and answering questions that could have been anticipated. When the material already exists and the difficult questions have already been answered, that phase compresses, and a shorter exclusivity period is a safer exclusivity period.
It also changes what the buyer can do with what they find. Price chipping late in a process works because the seller has invested months, has usually stopped talking to other buyers, and has often mentally spent the money. Removing the ammunition in advance is the only reliable defence, and it is far cheaper than the alternative. At Conclave Partners we would rather spend three months preparing a business than three months defending it.
An examination of your own business, commissioned by you before a sale process, covering earnings quality, contracts, legal and tax records, and operational dependencies. The purpose is to find and fix what a buyer's advisers would otherwise find later, when discoveries cost more.
Often yes, but scope should be proportionate. Full vendor due diligence is designed for larger transactions; a smaller business is usually better served by a scoped earnings review plus a legal health check. The test is whether the cost is small relative to the price movement a single unsupported adjustment could cause.
Yes, deliberately and in a structured way. Issues disclosed at the outset are priced once. Issues found in diligence are priced twice, because they also damage the credibility of everything else disclosed. A known-issues schedule with quantum and proposed protection is the practical format.
Adjusted earnings that cannot be evidenced. Add-backs asserted rather than supported, personal costs that cannot be cleanly identified, and monthly accounts that do not reconcile to the statutory ones account for a large share of renegotiations and failed deals.
Through the mechanism that sets the normal level required at completion. If the buyer's definition of normal is higher than yours, the difference comes out of the price. Preparing your own twelve to twenty-four month monthly analysis, with documented positions on deferred revenue, deposits and provisions, is the most effective protection.
Twelve months for anything that has to show up in the accounts, such as removing personal costs or reducing owner dependency. Nine months for contract and corporate housekeeping that may require consents or renewals. Six months for the earnings review, once the underlying reporting is clean.
Ildar Zakirov — Conclave Partners ildar@conclavepartners.com
Sergi Kosiakof — Conclave Partners sergi@conclavepartners.com