Throwing the Skeletons Out of the Closet

No one is perfect. Businesses are typically run by imperfect risk-takers. This is one of the main reasons companies require some degree of spring cleaning before they are ultimately sold. This includes everything from legal issues to financial aberrations which could not only put the business in a bad light, but could ultimately cause a deal to unravel — both before and after complete due diligence.

Of great importance is the need to pull the proverbial skeletons out of the closet prior to selling the business. This principle is best illustrated by a real-life example of a client of ours.

Our client was in the food services industry, supplying a large number of both distributors as well as direct clients in a very niche industry. At the outset of our engagement with this particular client, we were explicit in ensuring there were no skeletons in the closet.

We asked several pointed questions, including those related to employees, financials and even legal matters. The owner was adamant about the pure squeaky-cleanness of his business.

We prepped the company for sale and brought several highly qualified cash buyers to the auction block. In doing so, this particular client received an extremely generous offer from the larger of the three final bidders.

The all-cash offer was quickly accepted by the seller and due diligence commenced immediately with a 60-day anticipated close date on the transaction. As due diligence commenced, one question arose that caused the deal to fall apart immediately:

Are all of your employees legally documented and able to work in the United States?

Unfortunately for all involved, the seller had failed to divulge the fact that nearly 15% of the company's workforce were undocumented — a fact which should have not only been revealed long before the sales process had begun, but should have been remedied before we had even begun speaking with buyers.

Are there skeletons in the closet of your business? If so, they will need removing before you even think about selling. Otherwise, your company could become another wasted M&A statistic of deals that never crossed the finish line.

Why Sellers Hide Problems — and Why It Always Backfires

The instinct to conceal a business problem during a sale process is understandable. Sellers worry that disclosing a legal issue, a customer concentration risk, or a compliance gap will reduce their valuation or scare off buyers. In practice, the opposite is almost always true. Buyers and their advisors are experienced at uncovering problems during due diligence — and discovering an undisclosed issue during that process is far more damaging than hearing about it upfront.

When a problem surfaces during diligence that the seller knew about and did not disclose, it does more than kill the specific deal point. It destroys trust in the entire transaction. Buyers reasonably conclude that if the seller hid one thing, there may be others — and they either walk away or dramatically re-price the deal to account for unknown risk. By contrast, a seller who proactively discloses a known issue and presents a credible remediation plan is demonstrating integrity, which is itself a factor that sophisticated buyers value.

Common Skeletons Advisors Encounter

While every business is different, certain categories of undisclosed issues appear repeatedly in pre-sale diligence. Understanding what buyers look for helps sellers identify and address problems well before the process begins:

• Employment and labor compliance — documentation requirements, classification of contractors vs. employees, wage-and-hour compliance, and workplace safety records
• Environmental liabilities — particularly for manufacturing, food production, or industrial businesses, legacy contamination or permit violations can be deal-stoppers
• Customer concentration — a single customer accounting for a large percentage of revenue creates binary risk that buyers price aggressively
• Undisclosed litigation or regulatory investigations — pending claims or regulatory inquiries that are not in the financial statements but are known to management
• Financial restatement risk — revenue recognition practices, related-party transactions, or off-balance-sheet obligations that could require adjustments to reported earnings
• Intellectual property gaps — software, processes, or branding that is used commercially but not properly registered or documented

For sellers who want to understand how buyers will evaluate these issues systematically, reviewing a thorough due diligence request list is an instructive first step — it shows exactly what a sophisticated buyer will ask for.

The Pre-Sale Audit: Cleaning the Closet Before the Process Starts

The most effective way to manage skeletons is to find them before buyers do. A pre-sale audit — conducted by the seller's own advisors with the same rigor a buyer would apply — surfaces issues when there is still time to remediate them. Depending on the nature of the issue, remediation might mean resolving pending litigation, restating financials, reclassifying workers, or simply documenting processes and policies that exist informally but have never been formalized.

A well-organized pre-sale process also includes building out a clean, well-indexed virtual data room so that buyers can efficiently verify the seller's disclosures during formal diligence. An organized data room index signals to buyers that the seller runs a professional operation and has nothing to hide — which itself reduces the buyer's perceived risk and supports the valuation. If you are preparing to start a sale process, beginning with a transaction readiness assessment can help identify which issues need attention before you go to market.

Frequently Asked Questions

What happens if a skeleton surfaces after the deal closes?

If an undisclosed issue is discovered post-close, the buyer's primary remedy depends on how the purchase agreement was structured. Most purchase agreements include representations and warranties from the seller covering the accuracy of disclosed information — and indemnification provisions that require the seller to compensate the buyer for losses arising from breaches of those representations. In cases of intentional concealment, the remedies can extend beyond contractual indemnification to fraud claims. This is why buyers increasingly purchase representations and warranties (R&W) insurance, which provides additional protection and reduces the direct financial exposure on the seller-side escrow.

How early should sellers begin cleaning up issues before going to market?

The general answer is: earlier than feels necessary. Some issues — such as resolving pending litigation, restating financials, or remediating environmental conditions — can take a year or more to fully address. Sellers who begin the process six to twelve months before launching a formal sale process have the most flexibility to address problems on their own terms rather than under deal-timeline pressure. Even issues that cannot be fully resolved can often be disclosed in a way that limits their valuation impact if the seller controls the narrative and can demonstrate active remediation.

Will disclosing a problem always reduce my sale price?

Not necessarily. Buyers price for risk, and uncertainty is typically more expensive than a known, quantified problem. A seller who discloses an issue and provides supporting documentation — the scope of the liability, the remediation plan, and the worst-case exposure — gives the buyer something concrete to underwrite. A seller who discloses nothing leaves the buyer to imagine the worst. In competitive auction processes, buyers who are comfortable with the risk profile of the business are more likely to submit aggressive bids than buyers who are working from incomplete information.