Buying a Business

Buying a Business: The What and How of Due Diligence

There are two basic ways to get into business – you can start a new business from scratch, or you can buy an existing one and take over operations. If you are more drawn to the latter than the former, knowing how to properly buy a business is critical.

Perhaps the most important phase of buying a business is known as “due diligence”. Below, we’ll talk about what that is, why it matters so much, and how you can go through it like a pro. Of course, if you find that you need legal help to make sure due diligence is performed properly, the team here at Fisher Stone is ready to serve you.

What is Due Diligence When Buying a Business?

Performing due diligence means carefully examining all aspects of a business before moving forward with a purchase. In the due diligence process, you can work on deciding if you actually do want to make the purchase, and if so, at what price. By the time you reach due diligence, you have certainly been told plenty of things about the business by the seller. Now, it’s time to get to work on confirming that what you were told is true and that the business is truly as strong as advertised.

Some potential business buyers get hung up on the idea that going through due diligence makes it seem like they don’t trust the seller. This is particularly common when the two parties know each other in some way. The buyer might not want to make it seem like they are suspicious or doubtful, so they may only dip lightly into the due diligence process.

This is a big mistake. Going through due diligence isn’t about a lack of trust or anything like that. It’s simply protecting the money and time you are going to invest in the business. You need to make sure that the business is worthy of your time in its current state and that you pay a fair market value for the entity. Any good business owner who has nothing to hide will completely understand the need for this homework and will be helpful to make sure you have access to everything you need.

A Few Key Components

As every business is different, even within the same industry, there are always going to be some variables to consider regarding how due diligence is performed. You’ll want to customize your approach to the business in question to get the right information without wasting time on things that aren’t relevant.

With that said, the four general components of due diligence listed below are going to apply in virtually every situation, so they are a good place to start.

• Financial research. This is, naturally, a critical part of the process. You have probably been provided some basic financial information as you’ve been in discussions to buy the business, but you need to dive deep into the data to make sure things look as expected. This will include a detailed review of financial statements, going over tax records, checking on the status of accounts receivable and payable, and more.
• Legal research. Most businesses are going to have a range of contracts and other agreements in place as part of how they do business. Do all of the terms in those contracts look acceptable to you? Can the contracts that don’t look so attractive be renegotiated once you take over ownership? This part of the due diligence process will also involve reviewing any active litigation to understand the risks and liabilities you’ll be accepting as the new owner.
• Operational research. This involves getting down into the granular details of how the business runs from day to day. Are the right employees in place to keep things running smoothly, and will those employees stay if the business is sold? Also, it’s a good idea to get to know the customer base at this point to determine how many customers the business serves and whether or not it is reliant on just one or two key customers for the bulk of the revenue.
• Market research. Finally, it’s a good idea to zoom out and look at the bigger picture of the market around this business. Is the market strong and is there a good outlook moving forward? How stiff is the competition in your area? Taking some time to gain an understanding of how the business works will help create a clearer picture of what the company is worth and what you can expect from it in the future.

Even the best due diligence can’t see the future perfectly. There is no way to know exactly what to expect out of any business or market, so even your best efforts will likely fail to reveal some things that come to light later.

That doesn’t mean that this time and effort will be wasted, however. You are sure to learn a lot about the business during due diligence, and the information uncovered may lead you to change your offer for the business, or you might even take the offer off of the table entirely. Whatever the case, you’ll be better off for having done the work, and assuming you do move forward, you’ll have more confidence that the deal is a good one.

How to Perform Due Diligence Correctly

It’s one thing to know that due diligence is important, it’s another thing to do it the right way. Building a plan, with the right people to help you, and then executing that plan will give you confidence when signing on the purchase that everything is as it seems. It’s a good idea to build a custom due diligence checklist for buying a business at the start of the process so you don’t miss any points along the way.

In addition to making your due diligence checklist for buying a business, you should also view building an expert team as one of your key steps. This is not a process that you want to go through alone unless you happen to be an expert in all of the various fields that come into play. You’ll need someone qualified to review the financial statements – an accountant, most likely – along with a legal expert to go over contracts, and perhaps an industry expert to do a review of the overall market and the businesses’ place in that market.

Once you have a solid team in place to help you through the process, formally request documentation from the seller of the business. These documents are going to be extensive and it might take a bit for them to be ready to review (although an organized seller will know what to expect and may have them ready in advance). Confirm with the seller that what you are being provided is complete and organized so your due diligence process doesn’t run into any problems.

Site visits are also an important part of due diligence and won’t be captured in any documentation. It’s important to visit the business – or have someone visit on your behalf – to understand how it operates, spot opportunities for improvement, or areas of risk. Even if you have to travel to the location where the business operates to see it for yourself, taking that trip will be worth it in the long run for the insight that you will gain.

Where It Can Go Wrong

Making a mistake, or simply overlooking something, in the due diligence process can prove to be very expensive. Watch out for these potential errors along the way –

• Rushing the process. Good due diligence takes time. It’s easy to understand that you may feel like hurrying through it in order to buy the business and get to work, but that’s a mistake that can be costly in the end. Give your assembled team of experts the time they need to work through everything carefully and then give yourself time to digest their findings and determine how to move forward.
• Minimizing culture problems. Sure, the financial statements on a business might look great, but what about how the business operates from day to day? If the employees are unhappy, you’ll want to figure out why that is and what it could mean for the future. It’s easy to look at a business only as a collection of revenues and expenses, but there is more to it than that.
• Trying to do it all alone. We mentioned this above, but it bears repeating – good due diligence is going to involve experts. You might have enough knowledge and experience to do one part of the process on your own – market research, perhaps – but you’ll need other professionals to fill in the gaps and do this review properly.

Get It Right the First Time

If this will be your first business purchase, you certainly want to know exactly what you are getting – and what you are getting into. Making a mistake on the purchase of a business can be financially devastating and it may take years to recover. Before you sign anything on a potential purchase, take a moment to contact Fisher Stone to better understand the process and what you need to watch for along the way. The help of an attorney will be invaluable to make sure you don’t walk into a situation that you soon regret. We look forward to discussing this exciting opportunity with you shortly.