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Buying a Business- Due Diligence

05-Jan-2015

Buying a small business is a huge financial investment for anyone leveraging their assets. In order to make the right decisions, buyers will go through a “due diligence process.” Due diligence is defined as “a comprehensive evaluation of a business undertaken by a perspective buyer in order to verify its assets and liabilities and profits and losses.”

The due diligence process can be a challenging time for perspective buyers especially if they are venturing into industries that they are unfamiliar with, are cash based (i.e., bars & restaurants), or highly regulated (i.e., assisted living and group homes).

If you are buying a business, it is a good idea to understand the key steps in the due diligence process prior to signing a Purchase Agreement. What are the critical considerations for looking into the acquisition of a going concern venture? 

            1. Verify Financial Information- Think like a bank  

For small business loans, banks are typically going to want to look at three years of tax returns, Profit & Loss Statements (P&L) and Balance Sheets. Additionally depending on the time of year, they will request an YTD (year to date) P&L. These documents will allow perspective buyers and lenders to determine several things including the overall business trend and performance. A business with a declining trend will be challenging to finance and an unwanted turn-around challenge for a new owner. 

2. Why is the business being sold?

There must be a good reason why the owners of a business want to sell it. Common reasons that motivate principals to sell are raising funds for an estate tax payment, burnout, divorce, loss of a partner, or retirement. However, there may also be hidden reasons, such as the expectation of a lawsuit, a downward trend in the company’s prospects, or the loss of a key customer or employee. One of these hidden reasons could present a significant problem in completing the business sale transaction.

3. Corporate, Legal & Regulatory Matters

Organization- How is the business organized? If it involves a large number of disparate subsidiaries that deal with many products and services, it may be too difficult for the acquirer to manage the operation. These types of businesses are also difficult to grow. Conversely, a company with a simple product line or service is an excellent acquisition target. The starting point for a thorough legal due diligence is to review the articles of incorporation and to obtain a chart that states which subsidiary entities are owned by which parent companies, where each one is incorporated, and the ownership of each one. Perspective buyers should examine the Certificate of Incorporation and Bylaws, Minutes of all meetings and materials presented.

Due diligence is a worthwhile process and if you get it right, there can be many reasons why buying an existing business could make good business sense for you. The main benefit of buying an established business is the mitigation of initial risks of start-up. Getting a business off the ground is often the riskiest and most difficult stage of a new business venture. Existing businesses provide a level of safety and profitability not found in start-ups.


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