Buying a business: due diligence

satisfying the conditions of due diligence

Satisfying the conditions of due diligence

We have successfully negotiated agreement upon an offer to purchase based on the information our business broker and the seller have provided.  This offer included many conditions that we must be satisfied with prior to closing or the offer becomes null and void and our deposit, refunded.

We must now plan and execute a reasonably thorough analysis of the business and the information provided. Our goal is to identify any fatal flaws, verify that the information is reasonably accurate and confirm that this business will really work for us. Professional advisers can help us with this process, called due diligence.

Our business broker will assist us in developing a diligence plan and coordinating its execution, but they will not do the diligence for us. It is our responsibility as the purchaser to do this to our satisfaction. Keep in mind that we will have to work from the existing documentation, whatever records the current owner has.

While we may need the advice of an accountant, we will need the advice of a lawyer. Accountants tend to see diligence from only a financial perspective—we need to address a bigger picture. Our accountant will help us verify cash flow, assets, liabilities, financial history and projections. They will also review tax filings, associated risk, corporate structure and potential tax issues resulting from our purchase. Have them go a step further to review financial control systems and make recommendations we can employ when we take control of the business. We also want to involve them in the preparation of our business plan and financial projections—this may help in securing financing.

Most purchasers buy a business with the intention of growing revenues and increasing profits and cash flow.

During their first year of ownership, most new business owners see revenue increase some 15% to 30%—a result of new energy, different skills and the assistance and support of the previous owner.

We need to focus on long-term growth. Typically, increasing profits requires increasing sales leads, improving the conversion rate and increasing the number of transactions per customer, the average sale value and the margin on each sale. Can we do better in one or more of these areas? To determine this, we need to assess many aspects of the business beyond the financials and legal diligence.

An experienced tax and transaction lawyer will advise us on their findings, the risks and how to structure the transaction and the business after our acquisition. They will also review the ownership and transferability of the intellectual property. Keep in mind that there will always be some risks and that we are the buyer—not our accountant or lawyer. Listen to their advice and that of your business broker but the decision to proceed or not must be yours. I have rarely heard an accountant or a lawyer recommend that a buyer proceed with an acquisition. Their job is to keep you from making a mistake or taking undue risk. The only way to avoid risk is to do nothing. You must decide if the risks are acceptable.

Will the business meet your needs

We must confirm that the business can generate sufficient cash flow to 1) support us,  2) do the debt servicing to pay for the business over a reasonable period of time and 3)  provide a return on our invested capital. If it falls short now, we must have a vision of the changes we can make to ensure it meets these needs in the future.

Assess the market —its size, desires and how it is being approached. The level to which the business’s product or service is currently accepted may not be indicative of the future. We recommend surveying present satisfaction and future purchasing intentions of existing clients. Sellers who haven’t tested sometimes misjudge and misrepresent.

Is there a future for the product or service? Changes in population, lifestyle and trends, legislation, interest rates and economic fluctuations and so on have to be considered. Can we improve leads, conversions and volume of sales? Do we have the right sales people and processes, marketing and sales tools, testing and measuring systems? Can pricing be increased? Can costs be reduced? Do the changes require additional capital investment? If so, do we have sufficient capital or credit for these changes?

For the first six months of ownership, we usually recommend that new owners operate the business the same as the previous owner ran it. Retaining current clients, skilled staff, existing supplier relationships and the confidence of the marketplace is important and your experience over the first six months will give you a better understanding of the systems and processes already in place and give you a basis for benchmarking changes you may then wish to make.

The basis of most good businesses is their systems and the competence and attitude of the employees who operate those systems. You will be able to review the systems during due diligence. While the need for confidentiality makes it hard to assess employees before closing the purchase, you can learn much about them from the current owner, from seeing how they are currently performing and from your customer survey. You should review the files the business had on each employee as well as HR systems and policies.

You also need to assess their technology. Is it adequate? What can be improved? Review the existing facilities and related agreements including leases, maintenance, warranties, current suitability, expansion potential and future options. Are licenses and permits current and transferable? Are furniture, fixtures, and equipment serviceable?  Can they support the business in the future? With equipment, technical and economic obsolescence is an issue—sometimes a perfectly good piece of equipment should be replaced by a newer version with lower operating costs or more desirable features. You may need the help of a knowledgeable technician to make such an assessment.

We’ll discuss more aspects of due diligence next issue. If you have questions about buying or selling a business, please contact Sunbelt Business Brokers at ottawa@sunbeltnetwork.com or 613-731-9140 or go to www.sunbeltcanada.com and one of our experienced agents will be glad to assist you.

And for tips on buying, building or selling your business, be sure to sign up for our monthly newsletter. You can see a sample of the newsletter here.

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One response to “Buying a business: due diligence

  1. Pingback: Buying a business: closing the acquisition | At the Broker's Table

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