So, what exactly is due diligence and why is it absolutely essential when purchasing a business?
Due diligence is definitely the most important aspect of any buying transaction. It is the period when you will have complete access to all company files and records as a final step to analyze the business and uncover any potential problems.
While the legal due diligence period usually starts after an agreement is made with the seller, to stay clear any pitfalls a buyer’s methodical investigation of the business should start the instant a business becomes of personal interest. And therefore, due diligence is an essential aspect of the buy a business process.
The due diligence process goes much further than a simple overview of financial documents and tax returns. In actual fact, due diligence when buying a business involves every detail associated with the business in question.
The due diligence checklist begins with the information gathering stage. This will enable you to establish a pros and cons list about the business. During this due diligence process, think of yourself as a detective trying to uncover everything you can about the business. Before approaching the seller, do a bit of basic information researching utilizing the Internet. As part of your due diligence checklist, search online records to learn what you can about the business you are interested in buying. Also do online research into the industry sector, suppliers, competition and the overall market outlook.
Based on the information gathered, formulate questions that need to be asked of the seller. If you are pleased with what the information is revealing about the business, it’s time to move on to the next phase of the due diligence process and contact the seller.
Due diligence when buying a business is extremely important when making an offer prior to acquisition. At this point, due diligence is crucial when going over all of the business records. As part of the due diligence process, write out a comprehensive list for the seller of all the materials you need to study. Then, create a timeline for yourself on what you plan to investigate, how long you plan to dedicate to each segment of the business, and which parts you are going to need professional advice, such as from a CPA or business lawyer.
While many sellers or brokers like to rush the inspection phase of the due diligence process, allow yourself the time you need. A minimum of a 20 business day time period is an acceptable amount of time for the inspection stage in most contracts, but if you need longer, don’t be afraid to ask for it. And keep in mind, the legal due diligence process that’s clearly stated in any business buying agreement shouldn’t start until you have in your possession all the requested materials from the seller.
Take your time when reviewing all the business operations books, financial statements and tax records. Have your due diligence checklist handy to jot down questions, follow-ups and other things you need to check out with the seller. As part of the due diligence when purchasing a business, it’s normal to discover inconsistencies or potentially questionable items. Write them all down on your due diligence checklist and set up a meeting the seller when you’ve finalized your due diligence process. The information will help you build your case in determining whether renegotiation of the price, terms or deal conditions may be necessary.
If your due diligence uncovers some major problems and the seller declines to renegotiate the deal or fails to accept your solution, then you must have the right to walk away as long as the agreement has language that allows you to do so. Therefore, make certain any agreement you sign protects you during the due diligence period when buying a business or else you may have a major problem. In fact, business industry statistics show that 5 out of 10 deals fall apart in the formal due diligence process stage.
If after completing your due diligence checklist you are not 100% certain about buying the business, then you might need to investigate further or walk away from the deal. Consider what about the business is giving you an uncertain feeling. Perhaps you need to gather additional information. Or maybe your due diligence revealed areas of concern that make you feel uneasy. Or it could just be cold feet. If additional due diligence will not ease your concerns, then it’s best to walk away.
Due diligence when buying a business is all you have to go on in order to make an informed decision on whether or not to purchase the business. When conducted properly, your final decision should be an easy one.
Richard Parker is the President and founder of the prestigious Diomo Corporation - The Business Buyer Resource Center. His celebrated materials, seminars and consulting have encouraged thousands of aspiring business buyers from around the World to pursue their dream of buying a business.
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