Diligence Readiness

The first document a serious buyer sends after agreeing a price in principle is a request list. It runs to pages. It asks for revenue by customer for three years, for the results of lien and litigation searches, for confirmation that every tax filing is current, for the status of every contractor, for every licence the business holds. Many owner-run businesses have never assembled any of it, and the weeks spent assembling it are the weeks in which surprises surface: a lapsed permit, a recorded lien, a contractor who should have been an employee, a large customer who halved its orders without anyone noticing. From the moment the first surprise appears, the price is being renegotiated.

Diligence Readiness finds those surprises before a buyer can. It assembles two files, one testing whether last year's earnings are still there and one testing whether anything can take them away, so that adjusted EBITDA becomes a number a buyer's legal and financial diligence confirms instead of one the owner asserts. Once the work is done, the customer schedule and the liabilities file are maintained documents that answer the first questions on the day they are asked.

A customer book that passes

The customer schedule has to pass the concentration and retention bars a buyer at this anchor applies: no single customer carrying more than a modest share of revenue, the ten largest carrying well under half, and customers who produced the great majority of last year's revenue still buying this year.

These bars are tighter than on the first bridge because the buyer is in a different position. An owner-operator can work to keep a large customer personally. A fund that will not run the business cannot, so a single customer whose departure would change the business's results is a risk the fund has to price as though the customer might leave on the day of closing. Spread and recurring revenue is what lets that buyer stop pricing for it.

The schedule is built from the ledger, by customer and by year, for three years: revenue per customer, its share of the total, and a retention line showing which of last year's customers bought again and for how much. When one customer is above the bar, the remedy is growth elsewhere. The large account is kept and put under contract with the company, and the sales plan targets new accounts in the same segment until its share falls. Every customer that left, or whose spending fell sharply, is investigated, and the account lead records a one-line reason on the schedule. A buyer will ask about each of them, and an explanation written at the time is worth more than one assembled in the middle of diligence.

In the illustration, the largest customer carries 7 percent of revenue and the ten largest carry 38 percent between them, a book a fund can price without assuming any one account walks out on the day of closing.

A liabilities file with nothing in it

The liabilities file answers a different question, the one a buyer's lawyers ask: can anything outside the financial statements reach the earnings? The file is ready when every item in it is clean or disclosed.

It answers the question by running the searches the buyer will run. Counsel orders lien, judgment, litigation and tax-lien searches in every jurisdiction the business operates in, and every hit is resolved or explained. The outside accountant confirms that payroll, sales and income tax filings and payments are current, and any open notice is closed before the file is assembled. Counsel reviews each contractor against the applicable legal test, converts anyone who should be an employee and quantifies any exposure. Every licence, permit and registration is listed with its holder and expiry date, and any held by the owner personally is moved to the company.

Contractor classification is easy to overlook and can be expensive. A business that has paid people as contractors who meet the legal test for employment owes the employer's share of payroll taxes it never paid, with penalties, interest and sometimes benefits on top. In the illustration, four such contractors paid $60,000 a year for three years leave $57,600 of employer payroll tax unpaid before penalties. Found by the seller's counsel, that is a known figure that can be settled. Found by the buyer's lawyers, it becomes an indemnity or a holdback sized at the buyer's estimate, and a signal to look harder at everything else.

The data room

Once a sale is under way, the documents a buyer asks for go into a data room, a shared and controlled folder that the buyer's lawyers and accountants work from. A business that has not prepared builds it in a hurry, one request at a time, with the owner and an adviser trying to run the business and the sale at once. Documents arrive late and out of order, some turn out to be missing, and each gap prompts a follow-up question.

For a business that has done this work, the data room is mostly a copy of files that already exist. The customer schedule, the liabilities file, the search results, the filing confirmations, the contractor review and the licence inventory are current documents with dates on them, and they go in on the first day.

Speed matters here beyond the time saved. A buyer's team reads the way a business answers a request list as evidence of how it is run. Complete, dated answers on the day they are asked suggest records kept because the business needed them. Slow, partial answers suggest records assembled because a buyer wanted them, and they lengthen diligence, which costs the seller money and gives the buyer more time to find a reason to revisit the price. A business that can answer the first request list from its files has shortened its own sale and taken away much of the buyer's room to renegotiate.

What it does to value

The framework values this driver through two of the scenarios a buyer prices. The first is the largest customer leaving: as concentration falls below the bar, the probability and size of that loss fall, and the change is valued as the reduction in the value at risk. The second is a liability surfacing. A liability found and cleared before a buyer finds it is value kept, because one discovered in diligence comes off the price in full and often with a margin for the buyer's trouble. The concentration discount a buyer applies to the multiple at a given largest-customer share, which falls away as the share falls, is recorded separately as price. The driver ranks fourth on this bridge, after the three drivers that make the business independent of its owner.

What has to be in place first

The customer schedule is a report from closed accounts, so it needs revenue by customer from the reviewed statements under Books. Material contracts should already be in the company's name, from Relationship Transfer; the retention evidence is stronger and the liabilities file shorter once they are. And because the searches are the expensive part, counsel and the outside accountant are budgeted for them before the file is started.

Knowing that it works

Concentration is watched every month, as the largest customer's share and the ten largest customers' share of revenue over the trailing year. Retention is read each quarter, as the share of the prior year's revenue that came back from returning customers. And the liabilities file is counted for open items, unresolved search hits, open notices, unsupported classifications and permits nearing expiry, where the right number is none.

The practical test is a rehearsal. Whoever runs the crossing issues a typical first request list, and the owner produces each answer from the customer schedule and the liabilities file without asking anyone to go and find it. Then the owner signs the liabilities file as complete. A purchase agreement will ask the owner to make the same statement, with legal consequences if it is wrong, and signing it before any buyer asks shows whether the owner believes it.

Why it slips, and what holds it

A good customer can keep buying more until one account is the business, because nobody watches the share. A filing can lapse, or a claim go unrecorded, because the file was assembled once and then left alone.

A customer schedule refreshed every quarter, with an alarm set well below the concentration bar, catches the growing account and triggers the sales plan before the account crosses the line. A compliance calendar owned by the finance seat carries every filing, renewal and expiry date with a named owner, and the searches are rerun every year, so the file a buyer eventually opens is the one the business has been keeping all along.