Getting the facts - business due diligence

Business due diligence

So it's good enough to continue with?

You may be required to sign a confidentiality agreement to proceed with your business due diligence. Now is the time for the in-depth financial analysis. Do your projections; check the going rates, the market conditions, and the strengths and weaknesses of the business? Consult your solicitor and/or accountant to draw up an offer (there are a number of ways to value a business, your accountant will assist with this). Remember you are buying a business, not a job! - Usually your offer will be conditional upon certain aspects being satisfied. On conditional acceptance be thorough, check everything; call in an advisor, an industry specialist, and your accountant and lawyer. This will cost (be specific, ask for quotes), it will be cheaper than getting it wrong.

Now the facts! doing business due diligence
Every business will differ in what is required, but you will need to cover:

The financials - Inspect the business's books covering the past 3-5 years to judge its health and financial trends - the accounts may need to be normalised (adjusted to exclude interest payments, owner drawings etc), do they make sense? Is there a profit after owner's wages? How is the business trading? If the owner owns the building, are they paying market rental? What you are looking for here is if the business is making any money, and whether it is in a sound financial condition to provide the return you want? Work with your accountant or business advisor to check irregular figures and establish industry operating ratios - how do they check out against others?

What exactly is for sale - There is likely to be plant and stock of some description, how have these been valued? Plant will be generally be valued as; Either a Going Concern ie. The assets are valued as a working part of the business. Or at Salvage Value (the lesser) where assets are only worth what they would fetch individually if dismantled and sold. The final value will depend on whether or not the company is trading well. Are there patents, are they registered - where do they apply and till when, is there any intellectual property and is it transferable? What about licensing and lease agreements - the business may be worthless if either of these run out and cannot be renewed? There may be stock - how old is this, should some be discarded, has it been priced appropriately - ensure you know what does and doesn't belong. On inspection your Solicitor will be looking for evidence of ownership of equipment etc. What's being sold - the business, its assets or it's shares? Check out the risks.

Verify market demand - By now you should have an understanding of the market, what the going rates are, where this business is positioned, its market share, and what the market conditions are like. You would also have looked at the businesses competitive advantages and its strengths, weaknesses, opportunities and threats. What skills will you bring to this business? How healthy is this industry? Are there barriers to others entering the market? Is there an adequate margin, or are people price-cutting just to get the business. Has the owner been doing this to attract custom? It may help speaking to an industry specialist.

Do your projections - Use all the above, particularly the financials to project out 2 - 3 years what your profits will be. Do your most realistic scenario, then look at your best and worst cases. Great! So it's looking good - what about cash flow? Is it there - the bank will be most interested in this as every month they will want their money. Get your Accountant or Business Advisor to help or check you figures.

What's the Business Worth - You like what you see and want to make an offer, but what about the price? This section looks at how businesses are valued and has been treated as a subject in its own right.

Making an Offer - Usually your offer will be conditional upon certain aspects being satisfied. It is generally best if an offer is in writing, this can help prevent any confusion or misunderstandings. There are three options; 1) Get your Solicitor to do this. 2) Use a standard business sale and purchase agreement; you can generally obtain these through your solicitor or your business broker. 3) Do it yourself. Discuss this with your solicitor, he may suggest some appropriate clauses, or wish to view it if he thinks it is necessary.

There are a number of things you will want to cover; the names of the buyers and sellers, what is being sold, the price it's being sold for, terms of payment, warranties by the seller, and any special conditions (these provide some safety if things aren't as you have been lead to believe). Some common "Special Conditions" the agreement could be subject to are; the buyer obtaining suitable finance, the buyers solicitor approving the agreement and the lease, the buyers accountant approving the business's viability, any restraints of trade, having a period to conduct due diligence to approve the business's financial records, equipment, licences etc. Also if the seller is to terminate any existing employee contracts, and is to payout all wages, salaries and benefits owed. It is critical you seek professional advice on this.

At this stage, the deal is still contingent on your offer's conditions checking out okay. If they don't - then no deal, either walk or renegotiate.

Generally business due diligence only needs to be done once you have a signed agreement. In practice however much of this work is often done in finding out about the business and in determining what to offer. Next you need to decide.

These points are intended to act as prompts - they provide an overview only. When purchasing a business always seek professional advice.

By Richard O'Brien - nzbizbuysell
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