Due diligence involves thoroughly checking all the information the seller has provided, along with any details you’ve uncovered in your own research, to make sure the business is a good investment. It involves going through everything with a fine-tooth comb and weighing up the benefits and risks involved. It should be a complete evaluation of the business.
Of course, you should also engage professionals to help you perform due diligence (such as an accountant or lawyer) to ensure you have someone experienced in finance, law and contract negotiations on your side.
We’ve identified a few key areas for you to thoroughly investigate.
Investigating a business’s financial position and history is one of the first things you should do. Incomings, outgoings, sales records, expenses, debts and any future projections should reflect the asking price. If they don’t, you need to find out why. As a general rule, you should ask to see a few years’ worth of tax returns, balance sheets and cash flow statements to get a true view of where the business is at. You should also check that accounts are being paid and received on time, as this is a sign of a well-run business. When overdue bills are stacked up, or payments are falling behind, it could indicate more serious problems.
Engaging an experienced specialist to look into the legal side of a potential business investment is crucial and will ensure you haven’t overlooked any important legal matters. Double-checking copies of all contracts, legal documents (like leases, purchase and distribution agreements) and your obligations under all of these is a crucial step in your due diligence. It also pays to look at what you’re acquiring with the business, such as existing employees and what your responsibilities are there.
As part of the process, it’s important to do a detailed review of the business’s operations and industry environment, as well as understanding the seller’s reasons for selling their business. You should check the company’s organizational documents, corporate records and contracts to make sure everything is in good shape, including health and safety manuals and employee records. Reviewing the competition, industry, suppliers and the location of the business should also be part of the process. All of these things will affect the potential success of the business and need to be analyzed.
Why are you selling? What training is provided? Is your personality critical to success? What is your day-to-day role in the running of the business? These are all specific questions you should ask the seller. The answers will help you better understand what might be required of you and how much of the business’s success relies on the current owner.
If you find any gaps, or find the seller can’t answer some of your important questions, you’ll need to consider what implications this might have on how you run the business and what you’ll need to implement if you continue with the purchase of the business.
Assets and potential
Investigating fixed assets is just as important as thoroughly reviewing the intangible assets and potential of the business. Knowing exactly what’s for sale will help you accurately value the business and also determine opportunities and threats for the future. You should gain a complete understanding of the strengths and weaknesses, as well as the areas where there may be room for growth and which factors could stifle it. This will help you be more prepared for possible challenges that lie ahead.
While the above is not an exhaustive checklist, it should give you an idea of the factors you need to consider at this pre-contract stage. Consulting experienced professionals to help you conduct your due diligence is essential and will help you avoid finding any unwanted skeletons in the closet after you’ve closed the deal.
Remember, the information you collect during due diligence is highly is highly sensitive and confidential. The seller may want you to sign a non-disclosure agreement before you access this information, so be sure to expect this request.
Conducting thorough research can often be a lengthy process, but as the buyer it’s in your best interest to investigate as thoroughly as possible. Due diligence will ensure you have all the information you need to make a sound purchase decision, and agree to the price and terms. It will help you be as sure as you can that you’re getting everything you’re paying for.