By Jaap van der Westhuizen, AGA(SA)
PPRA-registered business broker | Cape Business Bureau
A prospective buyer will not rely only on an advertisement, an asking price or a verbal explanation of the business. Before committing to a purchase, the buyer and professional advisers will normally test the financial, commercial, operational and legal information supplied by the seller.
For that reason, a seller should complete a due-diligence readiness review before taking the business to market. The objective is not to make the business appear perfect. It is to make sure that the information is organised, material risks are understood, explanations are consistent and the seller is ready for the questions a serious buyer will ask.
A well-prepared seller can usually respond faster, reduce avoidable uncertainty and protect credibility. It also allows the broker to present the opportunity accurately without releasing sensitive information too widely.
This checklist provides a practical South African starting point. The documents required will depend on the nature of the business and the proposed transaction.
Selling a business is not only about finding a buyer. For the full sequence from preparation to handover, read How to Sell a Business in South Africa: A Practical Guide.
What is seller’s due diligence?
Seller’s due diligence is an internal review performed before or during preparation for a sale. It looks at the business through the eyes of a buyer.
The review should answer four questions:
- Is the information complete and reliable?
- Can the earnings and asking price be supported?
- What risks or inconsistencies will a buyer identify?
- What should be corrected, disclosed or explained before negotiations begin?
It is sometimes described as sale readiness or vendor due diligence. For a smaller owner-managed business, it does not have to be an expensive formal investigation. A disciplined review by the owner, broker, accountant and attorney can still identify many of the matters that could otherwise delay or derail a sale.
1. Confirm the proposed transaction
Before assembling documents, establish what is intended to be sold. Depending on the business and legal structure, a transaction may involve operating assets and the business as a going concern, or shares or members’ interest in the entity that owns the business.
Clarify:
- The business activities and income streams included
- The legal entity or owner conducting the business
- Whether shares, members’ interest or business assets are proposed for sale
- The trading name, intellectual property and digital assets included
- Assets and stock included in the price
- Treatment of debtors, creditors, cash and working capital
- Property included or excluded
- Contracts, licences and permits requiring transfer or consent
- Liabilities that may remain with the seller or entity
- Seller finance, if it will be considered
- The expected handover and transition support
The structure can have tax, VAT, employee, contractual and legal consequences. It should be reviewed by appropriate professional advisers rather than decided solely for marketing convenience.
2. Create a controlled due-diligence file
Set up one organised electronic folder or secure data room. Do not send documents from different email threads without a clear index and access control.
A practical folder structure is:
- Corporate and ownership
- Financial statements and management accounts
- Tax and statutory records
- Assets, stock and finance agreements
- Customers and revenue
- Suppliers and purchasing
- Employees and owner involvement
- Premises and property
- Contracts, licences and intellectual property
- Systems, insurance, disputes and compliance
Maintain a document index showing:
- Document name
- Period covered
- Version or date
- Person responsible for it
- Whether it has been reviewed
- Whether it may be released before or only after an NDA
- Any explanation or limitation
Access should be staged. Highly sensitive customer, employee and pricing information should not be disclosed to every person who makes an enquiry.
3. Corporate and ownership information
A buyer must confirm who owns the business or entity and whether the seller has authority to complete the proposed transaction.
Prepare, where applicable:
- CIPC registration documents
- Founding statement for a close corporation
- Memorandum of Incorporation for a company
- Share register or members’ interest information
- Director or member details
- Shareholder or association agreements
- Beneficial ownership records
- Annual-return filing information
- Relevant resolutions and signing authorities
- Details of subsidiaries, related entities or trusts involved
- Existing options, pledges or restrictions affecting ownership
- B-BBEE documentation where commercially relevant
CIPC currently requires companies and close corporations to deal with annual returns and beneficial ownership declarations, together with the applicable securities or beneficial-interest records.[1] The seller should verify the entity’s current CIPC standing rather than assuming that historic registration documents are sufficient.
If there is a disagreement between shareholders, members or spouses about the sale, address it before approaching buyers.
4. Financial statements and current performance
Financial information is normally the centre of the buyer’s review. It should show both historical performance and what is happening now.
Prepare:
- Financial statements for the latest three financial years, where available
- Latest management accounts
- Monthly turnover and gross-profit information
- Current-year profit and loss statement
- Balance sheet
- Cash-flow information where available
- Debtors and creditors age analysis
- Bank statements supporting material trading activity
- Detailed general ledger or trial balance where requested
- Budgets and forecasts, clearly identified as forecasts
- Explanations for unusual movements or once-off events
Check that the figures reconcile across the financial statements, management accounts, VAT records, bank statements and sales systems. Differences are not necessarily fatal, but unexplained differences undermine confidence.
Do not present a forecast as though it were an achieved result. State the assumptions, distinguish contracted income from hoped-for growth and explain who prepared the forecast.
5. Prepare a supportable earnings-adjustment schedule
Owner-managed businesses often contain costs or benefits that may not continue in the same form after the sale. These may include owner remuneration, private expenditure, once-off costs, related-party charges or non-recurring income.
Prepare a separate schedule showing:
- The adjustment
- Amount and accounting period
- Where it appears in the accounts
- Why it is considered non-core or non-recurring
- Supporting document
- Whether a buyer will need to incur a replacement cost
Be conservative. An expense should not be added back merely because the seller would prefer a higher earnings figure. If the owner performs an essential role, a buyer may need to employ someone to perform that work.
Normalised earnings should be capable of being explained line by line. This gives the valuation and asking price a more credible foundation.
6. Tax and statutory records
Prepare an accurate list of the tax registrations and obligations applicable to the business.
The file may include:
- Income-tax returns and assessments
- VAT returns and reconciliations
- PAYE, UIF and Skills Development Levy records where applicable
- Tax Compliance Status information
- Correspondence with SARS
- Details of audits, objections, disputes or payment arrangements
- Customs, excise or industry-specific records where applicable
- Supporting documents for material tax positions
SARS identifies corporate income tax, VAT, PAYE and related employer obligations among the taxes relevant to businesses and employers.[3] SARS also states that VAT vendors must maintain proper records and retain applicable VAT records for the required period.[2]
Do not describe the business as tax compliant unless this has been checked. Any arrears, disputes or incomplete returns should be disclosed to the seller’s tax adviser and addressed before the buyer discovers them.
7. Assets, stock and finance obligations
Prepare an asset register covering machinery, vehicles, equipment, furniture, computers and other items material to the operation.
For each important asset, record:
- Description and identifying number
- Location
- Age and condition
- Ownership
- Estimated current value
- Maintenance history
- Remaining useful life where relevant
- Whether it is leased or financed
- Outstanding balance
- Security, lien or notarial bond affecting it
Also prepare:
- Stock reports
- Slow-moving and obsolete-stock information
- Work-in-progress schedules
- Stock-valuation policy
- Latest physical stock count
- Insurance schedules
- Hire-purchase, instalment-sale and lease agreements
Clarify whether stock and working capital are included in the asking price or calculated separately at takeover. A buyer should not have to discover this only after making an offer.
8. Customers and quality of revenue
A buyer will test whether the revenue is transferable and likely to continue.
Prepare:
- Customer list, initially anonymised where necessary
- Revenue by customer
- Revenue by product or service
- Top-customer concentration
- Recurring versus once-off income
- Customer tenure
- Service-level agreements and contracts
- Pricing terms
- Debtor-payment history
- Discounts, rebates, credits and returns
- Current pipeline and order book
- Lost customers and reasons for losses
- Material complaints or disputes
Explain whether customer relationships belong to the business or depend mainly on the owner. If important contracts require consent before transfer, identify this early.
Avoid releasing identifiable customer data prematurely. Confidential information should be supplied only through an appropriate process and with due regard to contractual and data-protection obligations.
9. Suppliers and purchasing
Prepare information about the business’s supply chain, including:
- Key suppliers
- Percentage of purchases from major suppliers
- Payment terms
- Rebates and discounts
- Exclusivity arrangements
- Import arrangements and currency exposure
- Minimum-order quantities
- Supply interruptions or disputes
- Alternative suppliers
- Transferability of supplier accounts
Dependence on one supplier is a commercial risk, particularly if the relationship is informal or cannot transfer. A buyer will want to know how the business would respond if that supplier changed terms or stopped supplying.
10. Employees and owner involvement
Prepare a confidential employee schedule containing only the information required for the review.
It may include:
- Position and responsibilities
- Length of service
- Employment status
- Remuneration and benefits
- Leave balances
- Bonuses, incentives or commissions
- Written employment agreements
- Disciplinary matters or disputes
- Key-person dependencies
- Training and qualifications
- Statutory registrations and employment-related records
Also document the owner’s weekly hours, responsibilities, customer relationships, technical knowledge and decision-making role. A buyer must understand what will have to be replaced after the owner exits.
The treatment of employees can depend on the transaction structure and applicable labour law. Obtain specialist advice before making promises, changing employment arrangements or communicating a proposed transaction to staff.
11. Premises, property and environmental matters
If the premises are leased, prepare:
- Signed lease and amendments
- Expiry date and renewal options
- Rental, operating costs and escalation
- Deposits and guarantees
- Landlord correspondence
- Confirmation that rental is up to date
- Disputes, breaches or notices
- Assignment, change-of-control or consent provisions
- Zoning and permitted use
- Backup power and essential services
If property is owned, clarify whether it is included in the transaction and provide the relevant ownership, finance and municipal information. If the property will remain with the seller, set out the proposed lease terms for the buyer.
For businesses with environmental, health or safety exposure, prepare the relevant permits, inspections, incidents and remediation information.
12. Material contracts, licences and intellectual property
Prepare a register of contracts and legal rights material to the business:
- Customer contracts
- Supplier and distribution agreements
- Franchise agreements
- Agency agreements
- Finance and security agreements
- Software and technology licences
- Equipment leases
- Maintenance agreements
- Insurance policies
- Permits and operating licences
- Trademarks, domain names and copyright material
- Restraints, exclusivity and confidentiality agreements
For each item, note its term, renewal date, termination rights, change-of-control provisions and whether consent is required to transfer it.
If a licence or contract is essential but cannot transfer, the seller and buyer need a realistic plan before completion.
13. Systems, data and information security
Prepare an overview of:
- Accounting system
- Point-of-sale or operational software
- Customer and supplier databases
- Payroll system
- Backups and disaster recovery
- Cybersecurity incidents
- User access and administrator rights
- Website, domains and social-media accounts
- Third-party software subscriptions
- Data-retention practices
The Information Regulator’s POPIA material highlights security measures protecting the integrity and confidentiality of personal information.[4] Customer and employee data should therefore not be copied indiscriminately into a due-diligence folder. Use controlled access, redact unnecessary personal information and obtain advice where required.
Do not release passwords during early due diligence. Credential transfer belongs in a secure completion and handover plan.
14. Claims, disputes and undisclosed liabilities
Prepare a written schedule of matters that could create a cost, interruption or claim, including:
- Current or threatened litigation
- Customer and supplier disputes
- Employee disputes
- Tax disputes
- Warranty claims
- Regulatory investigations
- Insurance claims
- Personal guarantees
- Sureties
- Contingent liabilities
- Related-party balances
- Product or service complaints
- Health and safety incidents
A material problem does not always prevent a transaction. Failing to disclose it can cause far greater difficulty. The seller’s attorney should advise what must be disclosed and how it should be recorded in the transaction documents.
15. Business operations and market position
A buyer must understand how the business functions beyond the accounts.
Document:
- Products and services
- Pricing process
- Sales and marketing channels
- Competitors
- Seasonal trends
- Capacity constraints
- Operating hours
- Key performance indicators
- Systems and procedures
- Quality-control processes
- Maintenance requirements
- Growth opportunities
- Main threats and weaknesses
Growth opportunities should be realistic. Distinguish between an opportunity that has been tested, one supported by customer demand and an idea that has not yet been implemented.
16. Prepare a disclosure and explanation schedule
Create one list of matters that require explanation. Examples include:
- A decline in turnover
- Unusually high owner expenditure
- A major customer loss
- Expiring lease
- Employee dispute
- Tax arrears
- Outdated licence
- Financed asset
- Supplier dependency
- Pending capital expenditure
For each issue, state the facts, current position, supporting documentation and corrective action. Do not wait for the buyer to interpret an unexplained gap.
A consistent disclosure record also helps the seller and advisers keep track of information supplied during the process.
17. Protect confidentiality throughout the process
Seller due diligence does not mean making every document immediately available.
A controlled process normally involves:
- Anonymous marketing information
- Initial buyer screening
- Signed non-disclosure agreement
- Release of a confidential information memorandum
- Buyer meetings and clarification
- An acceptable offer or agreed due-diligence framework
- Controlled access to detailed records
The Cape Business Bureau non-disclosure process requires confidential information to be protected and advises intending purchasers to conduct their own due-diligence investigation.[5]
Keep a record of who received information, what was supplied and when access was removed. Do not include unnecessary personal information in shared documents.
Common seller-side red flags
A seller should expect closer investigation where there are:
- Missing or late financial statements
- Material differences between reported sales, bank deposits and VAT records
- Large unsupported earnings adjustments
- Significant cash sales without adequate records
- Heavy dependence on one customer or supplier
- No written lease or an expiring lease
- Assets subject to undisclosed finance or security
- Key employees without written agreements
- Extensive owner dependence
- Unresolved tax, employee, landlord or customer disputes
- Material licences that have expired or cannot transfer
- Forecasts presented without assumptions
- A reason for sale that changes during discussions
The correct response is not to hide the issue. Investigate it, obtain advice and prepare a factual explanation.
Seller’s due-diligence readiness checklist
Before opening detailed due diligence to a qualified buyer, confirm that:
- The proposed transaction and inclusions are clear
- CIPC and ownership records are current
- Financial statements and management accounts are organised
- Earnings adjustments are separately supported
- Tax and statutory records have been checked
- Assets, stock and finance obligations are listed
- Customer and supplier concentration is understood
- Employee and owner responsibilities are documented
- The premises arrangement is clear
- Material contracts and licences have been reviewed
- Data and intellectual property are protected
- Disputes and contingent liabilities have been disclosed to advisers
- Operational systems and growth opportunities are documented
- The asking price has a defensible basis
- Sensitive information is subject to staged access and an NDA
- The seller, broker, accountant and attorney use consistent information
Final thoughts
Seller’s due diligence is not about producing a flawless business. It is about entering the market with reliable information, a clear transaction proposal and a realistic understanding of the risks a buyer will examine.
The earlier problems are identified, the more opportunity the seller has to correct them or explain them properly. This supports a more orderly valuation, marketing, negotiation and buyer due-diligence process.
Preparing to sell your business? Contact Cape Business Bureau for a confidential discussion, or review how CBB can help you sell your business.
About the author
Jaap van der Westhuizen, AGA(SA) is a PPRA-registered business broker with more than 25 years of commercial experience. He assists business owners and prospective purchasers through the practical stages of business sales and acquisitions at Cape Business Bureau.
This article provides general business-broker guidance and does not constitute legal, tax, accounting, labour, data-protection or financial advice. Every transaction is different. Obtain advice from suitably qualified professionals before acting or entering into a binding commitment.
Sources
[2] SARS Obligations of a VAT Vendor
[3] SARS Businesses and Employers
