Buying An Existing Business Part VII of IX

Due Diligence

The phrase is composed of two words. "due" which the dictionary defines as "proper or adequate and "diligence", which is defined as "degree of care or caution expected of a person. Especially as a party to an agreement.

The due diligence phase is the time when you will have access to the company's books and records.

Once a price and terms are agreed upon by the buyer and seller due diligence should be performed. At this point the buyer should give the seller a down payment, and the seller should remove the business from the market during this critical period.

This critical investigation period can last up to four weeks for most small businesses. Keep in mind, however, the time period is negotiable.

A proper due diligence period goes beyond the financials. At a minimum you should also investigate the assets, the customers, the suppliers, the employees, the competition, the market, the industry, the sales strategy, marketing possibilities, contracts, legal issues, and so on. When you have finished your due diligence you should feel comfortable that you and the business are a match, and if something needs fixing you can fix it at a reasonable cost.

Now is the time you should get your accountant to help you identify risk areas. I've been in negotiations with business sellers for many years and  have been forced to "walk" on several transactions because I found out the numbers were not real.  I often had to be very creative during the due diligence process to find the real profit or loss of the business.

Take your time and analyze whatever documents are made available. Below is a small sample of a few items to look for:

          Organizational Documents
          Financial Statements
          Tax Returns
          Canceled Checks
          Employment Contracts
          All Outstanding Litigation If Any
          All Contracts And Outstanding Orders
          Computer Systems, Software And Other Technology
          Issues Regarding Environmental Problems
          Payroll Records
          Staff Files And  The Staff Manual
          Copies Of Pension And  Profit-Sharing Plans
          Union Contracts, If Relevant
          Contracts And Leases

Having completed your research and confirmed that the information provided to you is true and correct,  you have one of  three choices. You can accept the seller's offer and move on, you can rewrite your offer, or you can scrap this project.

                Some Final Tips

Measure the business against your business plan.

Keep in mind that if a business is for sale, there must be a reason why.

If possible avoid buying the receivables.

Remember save harmless clauses are only as good as the individual offering them. It is better to uncover any and all potential problems and deal with them before closing then it is to rely on save harmless clauses.

If you purchase the shares of the company, you are accepting any and all warranty liability costs and issues for warranty claims in the period prior to acquiring the business. This is one reason that most small businesses are "asset sales" rather than "stock sales".

Keep in mind that the seller will almost always disclose all the upsides and the positives, your challenge, which is part of the due diligence exercise, is to figure out the negatives and downsides.

Success in your quest!