Priming Your Business for Due Diligence

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In preparation for a due diligence process, there are a few things you can routinely update and use. Most of these things have to do with financial and business metrics, while others are legal requirements.

The Profit & Loss Sheet

One of the first things any interested party will expect you to provide is a Profit & Loss Sheet, often called the P&L. In its most basic form, it’s a spreadsheet outlining your expenses and revenue history, month over month. Some P&L sheets are highly detailed, down to describing each individual expense, while others group expenses into broader categories. All P&L sheets track the relevant business figures of the past, while some also include projections into the future.

There is a certain political element to this kind of document: it shows where you’re coming from, where you want to go, and where you will go if things continue to work the way they do right now. The projections, if sound, are particularly interesting for a potential acquirer. As the P&L is usually the first document a buyer gets to see, it is often used to anchor their expectations.

It is good business hygiene to have such a document from the beginning and to update it with the latest numbers once every month. This will allow you to have insight into the developments of your bottom line and give interested parties a quick and cursory glance into the current health and attractiveness of your business.

Internal Metrics

For the internal metrics of your business, I recommend using tools like ProfitWell or Baremetrics. Those business analytics services hook into your payment processor and use your subscription data to extract trends, key numbers, and aggregate numbers. While many payment providers have rudimentary dashboards and statistics pages, these business metrics tools are focused on obtaining the most meaningful numbers and making them actionable.

Often, since these services aggregate business data from many similar businesses, you can see how well you’re doing compared to similar businesses that use those services. I always found it very reassuring to see that our churn rates were significantly lower than the average figures of businesses which had customers with similar lifetime values. We learned of a few parts of our business where we lagged behind, and that allowed us to focus on improving neglected areas of the business like the number and value of failed credit card charges.

All the business analytics services have slightly different ways of calculating values like your Monthly Recurring Revenue, and they may not be completely accurate—in fact, they probably won’t be as accurate as a tax report would need them to be. For example, this happens because, at some point, the developers who built those analytics tools made a choice about when a charge should be counted as “completed”: either when the customer subscribes, when their credit card is charged, or when the money actually hits your bank account. The same is true for unpaid but outstanding invoices: do they count? At a certain scale, this will make quite a difference in the final calculation. Every business analytics tool makes different choices here, so the numbers vary a little.

However, you get a lot of insight into customer segmentation, retention, churn, and other relevant SaaS metrics, for free or for a low price. Actionable information that allows you to make smart business decisions is worth a lot more than just having accurate numbers. It’s the actionable insight that you’ll be using these tools for, and it won’t make a difference if your churn is reported at 24.8% if it really is 24.5%—you have to do something about it either way.

These services offer read-only accounts with anonymized data that you can share with interested parties, so they have immediate insight into the metrics of your business without being able to see who your customers are.

The Power of Forecasting

Where analysis tools look into your past, forecasting tools look into your future. A tool like Summit will hook into your payment processor’s data as well, and then give you projections and forecasts into the future of your business. You will be able to set goals and simulate how your growth would be affected if specific goals were reached or missed.

Forecasting will allow you to explore several scenarios of where your business could go if you made certain decisions that are hard to reverse and would be very risky to attempt in reality: hiring a number of people, switching to another audience completely, or pivoting to another kind of product. It’s business experimentation powered by statistical models that are at least less biased than your hopeful entrepreneurial perspective. It’s a projection of your ambitions into the future.

Being able to share this kind of projection will give your acquirer the confidence that you have thought about these things, and there is a statistically significant chance that the goals you have set may be reached in reality. If you have been using forecasting tools for a while, it will also show your buyer how well you’ve been able to reach the goals you have set. This will be very helpful in conveying your expertise as a founder and industry expert.

Becoming Aware of Liabilities

When it comes to legal tripwires, make sure you have your software licenses under control. Use tools that extract all the licenses used in your codebase, and turn this into a living document. When you use software that has no license attached, you may need to replace or modify it to comply with legal requirements. The same care should be taken with intellectual property rights and any trademarks you may own. In general, everything that touched a lawyer’s hands at some point should be part of your digital documentation.

Are you currently involved in any litigation or lawsuits, or have you been threatened with that? Disclose it immediately. If there are any customers, ex-employees, or partners that may cause you trouble, point it out. Mention and list all past legal actions by or against your company, too. These things will be found out, and unless you’re proactive about disclosing them, they will be the biggest red flags for buyers. Usually, at the first sign of legal trouble that was not mentioned immediately by the seller, a buyer will retreat from the acquisition. Be honest, forthcoming, and clear about the realistic consequences of those legal issues.

Codifying the Secret Knowledge

Finally, there are things that only you know: trade secrets, unfair advantages, insight into the industry that no one else has. How can you transfer that knowledge? You will need to find a way to put your insight into writing or another permanent and shareable form.

I recorded an 11-hour video walkthrough of the FeedbackPanda codebase before we sold the business so that my replacement would understand why the code was structured the way it was. That kind of information will differ for you, I am sure, but it needs to be ready to be transferred eventually, so it’s better to start early.

Prepare for Controlled Handholding

The due diligence process will require a lot of work and focus from you. While the buyer will ask for insight, just sending documents to them won’t do you any good. You will need to guide them to the information they seek, because the entire due diligence process is a trust-building exercise, and your involvement in building the relationship in this process will set the tone for years to come.

Start by explaining your documents and what they contain in an overview document. Provide a master document that gives your buyer quick access to the data they’re looking for at a glance. If you’re storing all of your documents in cloud storage like Google Drive, you can cross-link between documents easily. Anything you can do to speed up information retrieval will make the due diligence process less stressful.

While the due diligence phase usually comes with certain legal guarantees, don’t be naive: there will be bad actors in the field, and some people will just promise more than they’re willing to do. While most buyers are serious, some may just want to take a look under the hood of your business. For that reason, I recommend staging the release of information, starting with the least sensitive (like an accurate yet not too detailed P&L sheet), and keeping the most critical information (like your internal roadmap documents) until the very end. Don’t share secrets. Never let your buyer access the account details of your customers without anonymizing them. Imagine what could happen if a competitor, disguised as a potential acquirer, gets their hands on your customer data. Don’t make this possible.

Finally, make a checklist for yourself long before you ever get into the due diligence process. Your acquirer will likely also have one, and the more similar they are, the less you will have to scramble to prepare. Many serial acquirers will have a checklist that has been developed over many years, and they will make sure that all their bases are covered. You can help them develop that trust for you and your product by being meticulous about keeping your documents and affairs in order. The more organized you are, the less extra work will come your way. After all, you will still have a business to run during all of this.

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