Buying a Business: Conducting Due Diligence (part two)

The finishing line to buying your business is in sight— you want to get there ASAP. But you can’t shorten due diligence, an important and complex part of the purchasing process.

As described in Due Diligence in Buying a Business  (part one),  our goal is to identify any fatal flaws, verify that the information is reasonably accurate and confirm that this business will really work for us. And so, it’s essential we keep to the plan our broker has set out for us.

At our brokerage, we organize a due diligence planning meeting inviting the seller, the seller’s accountant, your accountant, you, and any other advisers you believe will be required during the diligence process. There will be a subsequent meeting with you, your broker, and your lawyer to deal with legal diligence issues and with the drafting of the agreement of purchase and sale, and related documents. However, in order to minimize your costs given that you may not proceed with your purchase, we recommend that you delay the meeting with your legal adviser until after other forms of diligence have been completed.

At this first meeting you will establish a diligence plan including an understanding of what documentation exists, what is required to be reviewed, who will be providing the items and when, and who will be reviewing them. Your broker will assist you in developing your plan and ensuring that the documentation is provided.

Keep in mind that you can only review what exists. You may wish to see audited financial statements but it is rare for a small business to have audited statements. Physical inspections of plant and equipment and inventory are typically done during off hours when employees are not present at the business.

Once financial, operational, market, and HR diligence have been completed to your satisfaction it is time to begin the process with the tax and transaction lawyer you have retained. Their goal is to arrive at a structure that works for both parties as well as drafting the documentation to implement your agreement. They will also undertake the appropriate searches to ensure there are no undisclosed liabilities, that corporate filings are current, that the minute book is up to date, and that the tangible and intangible assets being transferred are free and clear.

Use a specialist for this. Most lawyers are focused on other legal practices and not familiar with tax and transaction and intellectual property law. Get an estimate of fees from your accountant and your lawyer prior to embarking upon the due diligence and closing process. Your broker can provide referrals to a number of experienced accounting and legal professionals who can assist you.

Sequencing and timing

The due diligence process can take anywhere from two to six weeks depending on the complexity and availability of documentation. The legal diligence and drafting of agreements will require an additional two to four weeks. Allow sufficient time to do a thorough job without putting unnecessary pressure on your professional advisers.

Typically one of the conditions in your offer relates to you being able to secure appropriate financing for the transaction. At the completion of your first stage of diligence you will be able to prepare a business and financing plan. The eventual structure of the transaction and of the business must take into account the financing plan so it is prudent to secure a conditional commitment for your financing prior to beginning the legal diligence and drafting.

At the completion of due diligence there will still be doubts and fears however you should have enough information to decide that, all things considered, this business will probably work, or not work, for you.

Expect buyer’s remorse—it will set in about two weeks before closing. You will be nervous about the cash flow, about the impact on your lifestyle and about your ability to successfully manage and grow the business. This is perfectly normal. Talk it through with your business broker.

Likewise, the seller will be experiencing seller’s remorse. They will be nervous about your ability to successfully operate what has been their business. They will be nervous about the change in their lifestyle and worried about the financing they are providing to you. They may find it emotionally difficult to let go of their “baby.” This may be a good time to meet with the seller and your broker socially. Your job will be to alleviate the fears and concerns of the seller. Their job will be to alleviate your fears and concerns. Everyone’s goal is to make sure this is a successful win/win transaction for all parties.

The original version of this text was published online in our At the Broker’s Table series and included in my book Insider Tips on Buying a Business in Canada. Stop by one of our offices across Canada for your free print copyOr you can download a pdf copy of the book here.

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