Due diligence you mustn’t overlook

How to buy a business

When you’ve found a business that’s the right fit, it’s easy to get carried away with plans for the future. But it’s important to focus on the nuts and bolts of your business acquisition – if you want to avoid finding any unwanted skeletons in the closet after you’ve signed on the dotted line.

The concept of due diligence is a simple one. It essentially involves thoroughly checking all the information the seller has provided – and any you’ve managed to uncover for yourself as part of your background research – to satisfy yourself that the business is a good prospect. It does involve going through everything with a fine-tooth comb from leases to liquidity but it’s the best way to weigh up the values and risks involved. And at the end of the process, you should be as sure as you can be that you’re getting everything you’re paying for.

Due diligence usually comprises a complete evaluation of a business’s legal, financial and commercial standing. Unless you’ve had extensive legal and financial training yourself, you’ll most certainly need professional advice here – from an accountant and a solicitor experienced in contracts. Your aim at this stage should be to approach the final stages of negotiations with full disclosure on every aspect of the business so you know exactly what you’re getting and whether the asking price is a fair one.

1. Financial matters

One of the first things you’ll investigate is the company’s financial position. A thorough examination of its incomings and outgoings, together with any future projections should justify the asking price; if it doesn’t, find out why not. As a minimum, ask to see three years’ worth of tax returns as well as balance sheets and cash flow statements.

It’s not unreasonable for the seller to ask you to sign a non-disclosure agreement before sharing sensitive commercial information with you, so be sure to expect this request. One important check to make is that bills are being settled – and payments received – regularly and on time as this is the sign of a well-run business. Accounts owing and overdue bills – as well as falling behind with tax payments – could indicate deeper problems. You’ll want to see that both profit margins and cash flow are in a healthy state and you should always factor in the costs of any bad debts.

2. Sales records

Take more than a cursory look at sales records as they could give you a useful steer on the nature of the business. Analyse the figures to see how the company is performing and whether there are any significant spikes and dips that may correspond to seasonal patterns. It’s a good idea to ask your seller for figures on their top customers so you can explore their behaviour in more detail. If the seller doesn’t want to reveal their identities at this stage, they could employ a code.

You’ll also be keen to look at any business that’s in the pipeline. Examining a company’s financial history may give you a feel for how the business has grown over the last few years, but what you’re most interested in is how it’s set to perform in the future. A solid record of recurring business or forward bookings may give you more reassurance than any amount of historical figures.

3. The legal side

Be aware that the fallout from overlooking an important legal matter can be painful. Imagine if you took over a business without checking whether or not the property’s lease was transferable… It’s best not to take any chances here so instruct a solicitor experienced in business transactions and ensure you double-check copies of all contracts and legal documents, including leases, purchase agreements and distribution agreements.

Depending on the type of business you’re acquiring, you may also need to verify that there’s adequate insurance in place and any necessary licences and permits are valid. Be aware that if you’re acquiring employees with the business, you do have responsibilities to them, so it makes sense to learn everything you can about the terms and conditions of their contracts.

4. Rules, regs and important documents

Depending on the nature of the business, you may need to check that the company’s organisational documents, corporate records, contracts and compliance reports are in good shape. Health and safety manuals should be up to date, as should employee records, including details of any complaints or disciplinary procedures that are ongoing.

If you find a black hole where mandatory documents should be, it will have implications on the procedures you’ll need to institute before you can pick up the business and run with it. If the company owns any intellectual property that’s also included in the purchase price, check that steps have been taken to secure and protect it. And make sure you look at any related party transactions, should they exist – agreements or arrangements between the company and stockholders or directors, as this could impact your decision to buy.

5. Assess potential

It involves a bit of effort outside the company paperwork you’ll be scrutinising but gaining a complete understanding of your chosen business’s strengths, weaknesses, threats and opportunities is a key part of the due diligence process. The more you can discover about the business itself, the market in which it operates, areas where there may be room for growth and factors which could stifle it, the more prepared you’ll be for the challenges that lie ahead.

Analyse business operations carefully. Study market data to learn whether sales seem likely to grow, decline or level out, and consider whether current pricing strategies are realistic. If your offer includes equipment or stock inventory, make sure that their valuation accurately reflects condition, age and market conditions.

It’s not an exhaustive checklist, but this will give you an idea of the factors you need to consider at this crucial pre-contract stage. To some extent, the depth of your due diligence will correlate with the level of your investment – you may not be as thorough if you’re spending £5,000 as you are when you’re parting with £50,000, Nevertheless, it pays to be vigilant and if you dot all the i’s and cross the t’s at this point, it should be plain sailing from here on in.

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