Buying A Business: Due Diligence

 

The most critical and stressful part of acquiring a business is usually the due diligence phase that occurs after the basic terms of a purchase agreement have been accepted in the form of a Letter of Intent (LOI) or a conditional purchase agreement.  This article identifies key steps and common mistakes during the due diligence phase.

 

Acquisition due diligence includes much more than an in-depth analysis of financial statements.  The purpose of the due diligence phase is to validate preliminary information provided prior to the offer and to gain a full understanding of the business and financial risks associated with the business.  A good due diligence process will systematically and thoroughly evaluate all aspects of an existing business.  At a minimum, the key elements of due diligence should be divided into categories such as the following:

 

·        Organizational – Legal structure of company, shareholder agreements, etc.

·        Management & Employees – Organization chart, roles, benefits, salaries/wages, etc.

·        Financial & Accounting – Financial statements, tax returns, receivables, payables, inventory, fixed assets, payroll, insurance, etc.

·        Legal – Past, current, pending or threatened suits, claims, etc.

·        Permits & Licensing – Required permits or licenses to operate the business

·        Contracts & Agreements – Loans, leases, notes payable, equipment leases, govt. contracts, supplier contracts, etc.

·        Sales & Marketing – Products & services offered, sales by customer reports, sales by product/services report, pricing policies, refund & warranty policy, etc.

·        Intellectual Property – Copyrights, trademarks, trade names, patents, proprietary designs/processes, domain names, non-compete or confidentiality agreements, etc.

·        Equipment & Fixed Assets – List of equipment & fixed assets, estimated fair market value, repair & maintenance log, etc.

·        Insurance – Liability, Property, Workers Comp., Fire, Life, history of claims, etc.

 

Each one of these areas requires a thorough and detailed review.  The primary goals of the due diligence phase is to obtain full disclosure of all issues that affect the business both positively and negatively, identify business and financial risk and be able to reach a conclusion regarding the future success of the business.  It is very important during this phase that the seller fully discloses all material, known facts.

 

The most common mistake that many buyers make during the due diligence phase is to prepare a very long, multi-page check list of these items and simply send the list to the seller with a request to complete and provide all information requested.  It is our experience and opinion that direct buyer-to-seller communication in the form of collaborative question and answer sessions is by far the best method to obtain due diligence information.  The written responses to a typical due diligence list pales in comparison to the background and insights gained from direct, verbal discussion of those same items.  A collaborative approach, where both buyer and seller work together to discuss due diligence information and prepare purchase agreement schedules where appropriate, will also help to avoid miscommunication and missed expectations regarding due diligence information.  The process results in a written disclosure document but more importantly, provides the buyer with a much more informed understanding of the business.

 

Lastly, it should be both the buyers and sellers goal that the seller continues to run the business as usual, without disruption to customer service.  It can be easy for a seller to become distracted, overwhelmed and over-stressed by the daily demands of running the business while also tending to all the details and anxiety of completing an acquisition.  This is another reason the buyer should make every effort to collaborate with the seller during due diligence to make the transition as seamless and efficient as possible.

 

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