The Importance of Due Diligence when buying a business

If you’re serious about buying a business, there are a number of questions you’ll need to ask the seller. For example, understanding the financial position of the company, culture amongst employees and customer retention rate is important. Furthermore, you’ll also need an understanding of existing trademarks, sales data, stock and inventory, marketing plans and any outstanding, ongoing contracts, owner’s income and more. To assess this information, you need to go through the process of due diligence. 

Due diligence is the process of investigating or exercising a level of care before entering into any agreement or contract with another party.

For a buyer, this is an important part of buying a business; and as a seller, this process can be rather nerve-racking as the buyer will delve into all aspects of your business. This is an important time for a seller to remain calm and allow the buyer time to make an informed and confident decision to purchase. Due diligence may be performed by the interested buyer as well as their related parties such as accountant, business broker or lawyer.

The process of due diligence normally begins after the potential buyer has signed a confidentiality agreement and a letter of intent (which assumes if the business meets their expectations, they will buy it). Make sure that everyone who is viewing the confidential information signs an agreement. Your lawyer or business broker should be able to assist you with these documents.

What are the expectations of the seller during due diligence?

In order for the interested buyer to perform due diligence, all of the relevant financial, legal and operational information must be available. It is a good idea to prepare this information when you first decide to sell your business. If you are intending on advertising and selling your business privately without the assistance of a business broker, it will give you the confidence to understand your business’s viability and be ready to deal with interested buyer’s enquiries. 

When assessing a business’s health, an interested buyer will want to view financial records from the past 3 years. This gives a good picture of how the business has developed and if it has been affected by changes in the economy, climate, competition, staff, suppliers and much more. It allows you to forecast its growth and assess its viability.

Here is a checklist of the documents that a buyer should have access to.

Financials:

• Tax Returns, last 3 years

• Income Statements, last 3 years

• Balance Sheets, last 3 years

• Accounts receivable list

• Accounts payable list

• Owners Salary

• Financial forecasts if available

Shop Front:

• Stock Inventory and cost price

• Current Building Lease and Conditions

• Valuation and list of equipment and fixtures

• Servicing receipts

• Equipment leasing details

• Vendor and customer databases

• Website information - traffic, profitability, social media presence etc

Legal:

• Patents or trademarks

• Franchise Agreements, if valid.

• Business Registration (ABN), certificates, licenses.

• Employee agreements and records of employment

• Business loans

• Vendor, distributor, client agreements

• Website agreements - web hosting, ongoing web development and maintenance

• If it is a freehold sale - land title and any other contracts

Manuals / Plans:

• Business Procedures

• Business Plans

• Marketing plans

• Training Manuals

• Employee Manuals

• Equipment Manuals

Other than having these documents prepared, the due diligence is also an important time for the seller to assess the buyers financial stability and competence. Especially if the payment plan is based on a loan from the seller, there is a trial period before full payment, or the seller expects to remain connected to the business in some way. The seller wants to make sure the buyer has never been bankrupt or had a history of poor business practices. The seller needs to be content with who they are selling the business too and that they are capable of running that particular business.

What else can I provide to an interested buyer?

Selling your business is a lot like selling any product. Interest buyers are going to want to know in-depth information about the business, this is where a seller’s memo becomes important.

Remember, the process of due diligence is important for potential buyers. As a seller, make sure you do not mis-represent information as it can be very bad for the sale and lead to legal ramifications. Be honest and upfront about all aspects of your business. This process can take weeks for the potential buyer to be confident that everything has been reviewed and the business meets their expectations. Let them take their time and don't rush, as it can seem you are desperate for the sale or are trying to hide something.

Was this article helpful? Have you gone through the process of due diligence before? Do you have any suggestions for others who are buying or selling a business?