Do you really know what the term ‘due diligence’ means? In its most basic form, due diligence is simply the process by which you investigate a business in order to determine if it’s really as good a deal as it was presented to be.
For example, you may see a reasonable price asked for a profitable small business that seems like a great deal on the surface. However, after doing your due diligence you may learn that the financial statements for the business don’t add up to being nearly as profitable as they first appeared. You may also learn that the business skewed its cash flow figures by not paying any or all of its outstanding debts.
Due diligence gives you the opportunity to uncover any surprises that the vendor may be deliberately or unwittingly covering up to make the business appear better than it really is.
Before you buy any small business, it is important that you take the time to do your due diligence, regardless of the time or effort you may think it will require of you. Here are some things you need to include in your own due diligence checklist:
Why is the vendor selling the business now? Some people sell businesses for very valid reasons. They may have health or family concerns, or they’re simply acting on their own exit strategy. Others may be selling because they know the business has reached its peak and is starting to slide.
If you examine the market for what the business sells, you may learn that the market is saturated in a heavily competitive market. You may learn that technology is quickly replacing those products with alternatives, making the business less viable.
Take the time to inspect the business financials carefully. Ideally, you should look back through at least three years’ worth of financials, if they’re available. This will help to uncover any capital purchases for equipment or machinery that might have outstanding debts against them.
If necessary, enlist the help of your accountant to work out if anything has been deliberately tweaked to make it appear more appealing to a potential purchaser.
Does the business rely solely on passing foot traffic for customers? Or are there regular orders coming in from a solid base of the same customers every month? If you intend to purchase any business, you need some way of knowing whether those existing customers will stay with you after the business is sold. You may be able to determine this by evaluating any contracts or sales agreements that might be in place. This also lets you work out whether there is potential to increase the sales made to those customers for future growth forecasts.
Due diligence should also cover the condition of the premises in which the business operates. This should include investigating the terms of the current lease and the amount of rent payable on it to ensure that the business can stay in the same location for at least some time to come. It should also include checking that potentially expensive repairs or maintenance haven’t been put off, leaving those expenses in your hands once you take over.
Business Assets & Stock
What’s staying with the business after the sale and what’s not? What’s included in the purchase price in terms of assets and stock on hand? This level of due diligence should also uncover any agreements with suppliers and whether there are any unpaid invoices due for stock on hand or whether stock supplies may be limited or cut off for any reason.
Check whether the business has and maintains the requisite licenses and permits it may require in order to remain operational.
Staff, Contractors & Employees
If you’re considering taking over an existing business, you’ll want some level of assurance that the existing people who help to operate it will remain with the business after it has sold. You might consider whether any redundancies need to be made for extraneous staff, or whether new workplace agreements need to be put in place to retain others.
There are also plenty of other aspects to consider when you’re conducting your own due diligence on any small business. Before you simply believe that the purchase price for any small business seems like a real bargain, take the time to ask lots of questions and complete your due diligence properly. Ask your accountant to help you complete a due diligence checklist to be sure you haven’t overlooked anything.
When you’re done, you may just find that the small business you’re considering really is a good buy after all.