Due Diligence vs Valuation: What's the Difference? (2024)

Written by: Logan Speights

Introduction

Selling a business is a monumental task. It’s not just about slapping a price tag on the front door and waiting for a buyer. There are complex procedures and numerous considerations involved, key among them being due diligence and valuation. These terms are often thrown around interchangeably, but they play distinct roles in the business sales process. This article demystifies the difference between due diligence and valuation, delving into their respective processes and impacts on the successful sale of a business.

Understanding Key Concepts

Due Diligence: A Closer Look

Simply put, due diligence is the rigorous process of examining a business from all angles before purchasing. It is designed to protect both buyer and seller by ensuring all financials, customer relations, legalities, and operations are as presented.

In the context of selling a business, due diligence serves multiple purposes:

• Validates the accuracy of information provided by the seller.
• Assesses the overall health and viability of the business.
• Identifies potential risks or liabilities that may impact the transaction or the future performance of the business.

Valuation: More Than Just Numbers

Valuation, on the other hand, involves determining the economic value of a business or specific business assets. It is a complex process that includes a detailed review of financial records, market conditions, and business forecasts.

When selling a business, valuation provides:

• A starting point for negotiations.
• A reasonable expectation of the sale price.
• An essential tool for making strategic decisions, including when to sell.

The Detailed Process: Due Diligence

Initiation of Due Diligence

The due diligence process typically begins once a buyer has expressed interest and a preliminary agreement is in place (i.e., Non-Disclosure, Letter of Intent, etc.). However, businesses can and should conduct internal due diligence in preparation for potential buyers.

Stages of Due Diligence

The due diligence process entails several stages:

• Gathering and Evaluating Information: This includes collecting all necessary documents, such as financial records, customer contracts, and employee agreements.
• Verifying Information: This involves confirming that all presented data is accurate and up-to-date.
• Risk Assessment: This identifies any potential liabilities or issues that may deter potential buyers or decrease the business’s value.

By going through this process with a Certified Exit Planning Advisor (CEPA), like Proxxy, you can determine your organization’s “readiness” to sell and “attractiveness” to potential acquirers.

Role of Due Diligence in the Sale Process

Due diligence can greatly impact the sale process. It can influence purchase price, sale terms, and conditions, and can even determine whether the sale proceeds or falls through.

The Detailed Process: Valuation

Initiation of Valuation Process

Valuation often begins before the business is even on the market. A business owner might conduct a valuation to determine a suitable asking price or to gain a clearer picture of the business’s financial health.

Stages of Valuation

The valuation process follows three main stages:

• Gathering Financial Data: This involves compiling income statements, balance sheets, cash flow statements, and other relevant financial information.
• Financial Analysis and Forecasting: This step requires a deep dive into the collected data to assess current financial performance and future projections.
• Choosing a Valuation Method and Calculating Value: Different valuation methods are available, each suited to the specifics of your business, its sector, and past financials. For instance, a retail business might use a market-based valuation, comparing it to similar businesses, while a fast-growing tech startup might opt for a discounted cash flow valuation, which focuses on future earnings potential.

Role of Valuation in the Sale Process

Valuation significantly impacts the business sale process. It sets the tone for asking price, negotiation, and ultimately the final selling price. It can be the difference between a successful sale and a missed opportunity.

Differences Between Due Diligence and Valuation

Though both critical in selling a business, due diligence and valuation have distinct objectives, processes, and impacts.

Differences in Objectives

While due diligence aims to validate information and identify potential risks, valuation’s goal is to establish an economic value for the business or its assets.

Differences in Processes

Due diligence is investigative, focusing on verification and risk assessment. Valuation, on the other hand, is analytical and predictive, requiring a deep dive into financials and market conditions.

Differences in Impact on Selling a Business

The valuation process will tell you a range of what the market would likely pay for a company like yours. Conversely, the due diligence process will validate whether you are a viable acquisition and what, in that valuation range, you deserve to be paid for your company.

Importance of Both Due Diligence and Valuation in Selling a Business

Despite their differences, both due diligence and valuation are essential when selling a business. They ensure a fair sale, minimize risks, and facilitate a smooth transaction.

• Ensuring a Fair Sale: Due diligence verifies the legitimacy and accuracy of information provided, ensuring the buyer knows exactly what they are purchasing. Valuation, meanwhile, provides a credible starting point for price negotiations.
• Minimizing Risks: Due diligence helps to identify any potential risks or liabilities that could derail a sale or impact future business performance. Valuation considers these risks in the context of the overall business worth.
• Facilitating a Smooth Transaction: Together, due diligence and valuation set the foundation for a smooth transaction. They allow both parties to enter negotiations with confidence and a shared understanding of the business’s true value and potential.

Conclusion

Selling a business is no small feat. It requires extensive preparation, a deep understanding of the business’s financial and operational health, and a clear view of its value. This is where due diligence and valuation come into play. While both complex, their roles are crucial in ensuring a fair and successful transaction.

One last point worth mentioning, preparing for a business sale doesn’t necessarily mean you’re getting rid of it. It’s about being ready for any potential event, be it mergers, acquisitions, investments, or scale financing. A company like Proxxy, specializing in business operations and liquidity event preparation, can offer invaluable assistance in this regard. By understanding the processes and requirements needed for a future business sale, you also learn how to improve the way your business operates today and scales tomorrow. Remember, the journey to selling your business is a marathon, not a sprint, and every step taken in preparation is a stride toward success.

Checklist