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TWO KEY FOCUS AREAS
While all the facets of cleanup described in the following are important, the single area I would most emphasize are the financials. Analysis of the target company's financial records constitutes a very large part of due diligence, so it's crucial that the seller has paid close attention to the books. If you don't already work with a good accounting firm, this is the time to go find one. That should be your highest priority. Be sure your accountants adhere to strict, rigorous principles.
The other element I would emphasize is legal. This is the most commonly overlooked area, with painful or even disastrous consequences. One category of legal hang-up involves liability. Obviously, if there are any outstanding lawsuits pending that involve your business, it would be far better to resolve these before you sell the company.
But more typically, the source of legal problems is contractual: A seller will have a number of binding contracts in force that effectively "give away the store." That is, these legal covenants freeze key assets. For example, one customer might have exclusive rights to a product line of yours. If such a contractual limitation surfaces during the buyer's due diligence, that is a huge problem. Not only do you have to resolve the specific situation -- say, to pay the customer to release the contractual hold -- but you've also created a serious credibility problem. Many a deal has been scuttled this way.
