Due Diligence When Buying A Business

Due diligence is probably the most critical stage in the buying process. Many prospective buyers incorrectly identify this period as strictly a financial review, but it goes far beyond that. Due diligence encompasses a far greater project - that being the complete investigation and review of the business.

One of the keys to buying a good business comes from your ability to learn the intimate details of the business and to identify the strengths, weaknesses, pluses, minuses, growth opportunities and areas of concerns. If you do not do a flawless job of gathering information, you will not be able to pull the trigger and complete the transaction since you will be uncertain about too many components of the business.

When to Start The Due Diligence?

The investigation process begins the moment a business becomes of interest to you. Your goal is to make certain that you uncover everything about any business BEFORE you buy it. You don’t have to meet the seller or even visit the business for your research to begin. The Internet is an incredible tool that will allow you to investigate the business, the industry, the competition, the marketing, the suppliers, and on and on.
 

The importance of beginning your investigation early on cannot be emphasized strongly enough. This way, you will position yourself to ask the proper questions to the seller. Once you progress to the stage of an accepted offer, you will commence the inspection or financial due diligence. This period usually lasts 10-30 days. This is the time when you’ll have access to all of the company’s books and records.

Once you have been looking at a particular business, you will find a thousand things crossing your mind regarding the acquisition. Keep a notepad handy at all times and log your thoughts. You will have many thoughts about things “I need to check out”. Write these all in one place. Do not trust your memory; these little things are the ones that can come back to haunt you down the road. Begin to put together your checklist of what you need to investigate and how you are going to do it, along with the materials you may need from the seller to accomplish it.

The Right Attitude
A buyer should go into this stage with the goal of validating all of the information that has been represented. Of course you want to uncover any problems but the objective is not simply to find a lot of issues so you can renegotiate the deal terms. Certainly if you uncover issues that materially impact the business then renegotiating the terms, or possibly walking from the deal, may be necessary. However, you should have already done an in-depth analysis of the business’ fundamentals before entering this stage so that you can get down to the details and scrub the business rather than having to conduct a review of every aspect.

Allow Yourself Enough Time
Many sellers and some brokers will press for a very short inspection period; sometimes just days. Do not get bullied into this - allow ample time to complete this part of the process. Generally, you should negotiate a 20-business-day inspection/due diligence period. At times it is necessary to convey to the seller that if they limit the time you need it will only result in you being uncertain and thus not being able to close the deal.

On Site Observation
Some business types and especially those that have unreported income may necessitate an on-site observation. This will allow you to monitor the activity over a certain period of time and to reconcile the revenues with the seller’s records. This can be a sensitive issue and many sellers will not allow you to be on their premises. It is certainly not something that has to be done with every business, but if there is representation of “cash sales” where the seller wants to include this in their valuation, this is one step where you can possibly reconcile at least part of this alleged activity.

Prepare Properly
Since you will have some time restrictions (you may only have a limited number of days per the contract), provide the seller with a listing of all of the materials required for you and/or your team to complete this exercise. No matter what you are told, do not begin the process until they have everything ready for you. On the note of the professionals you will employ to help you, I always suggest that you first review the information provided on your own. There is no need to pay out hourly fees if the information is not organized, and if it doesn’t make sense to you, chances are it won’t make sense to your accountant either.

Be mindful of the time of year when you will conduct the due diligence. There are certain periods such as the end of fiscal quarters and after the calendar year-end where accountants are flooded with work and may not have time for you. As such, keep your advisors apprised of your deal timing in case you have to accelerate or delay the due diligence to accommodate their participation.

Dealing With Surprises
You will most likely find some surprises in every business; don’t panic, it’s normal. Work through them. Get clarification. Build your case. Don’t run to the seller or broker every time you find an inconsistency between what you’ve seen versus what you were told. No business is perfect. The rule to follow is to not treat any incidents as catastrophes nor any catastrophes as incidents. If you find a major problem, get your facts in order and you can then decide the appropriate action to be taken with the seller (i.e. renegotiation, walking from the deal, etc.).

According to industry statistics, nine out of ten people who begin the search to buy a business never complete a transaction. While there are many reasons for this dismal figure, a lot has to do with the inability of people to “pull the trigger”. This gun-shy reaction is related specifically to uncertainty that usually surfaces during the due diligence stage: if you have not gathered the right information or failed to investigate the business thoroughly, you will not be 100 percent confident of what to do. And so you will drop the project. Conversely, if you do a flawless job of investigating the business, and everything else adds up right, then making the final decision is simply one more step in the process.