Due Diligence in Buying a Business (Part 1 of 2)

By Amy Luoma




Due Diligence in Buying a Business (Part 1 of 2)

By: Amy Luoma

After an agreement is negotiated to purchase a business, the due diligence process is started. The goal is to identify any fatal flaws, verify that the information is reasonably accurate, and confirm that this business will work. Professional advisers are invaluable during this step.

Due Diligence

A business broker will help develop a due diligence plan and coordinate its execution, but they will not see it through. It is the responsibility of the buyer to carry it out to their satisfaction, using the records the current owner has.

An accountant can help us verify cash flow, assets, liabilities, financial history and projections, and review tax filings, associated risk, corporate structure and potential tax issues resulting from the purchase. If requested, they can also review financial control systems and make recommendations for when you take control of the business. Involving them in the preparation of the business plan and financial projections may help in securing financing.

Legal advice is also needed. An experienced tax and transaction lawyer will share their findings and advise on the risks and the structuring of the transaction and the business after acquisition. They will also review the ownership and transferability of the intellectual property. Keep in mind that there will always be some risks and that you are the buyer(s) – not your accountant or lawyer. Listen to the advice from them and your business broker, but the decision to proceed or not must be yours.  Some lawyers and accountants will not be comfortable recommending that a buyer proceed with an acquisition. Their job is to keep you from making a mistake or taking undue risk. The only way to avoid risk is to do nothing, so you must decide if the risks are acceptable.

Most purchasers buy a business with the intention of growing revenues and increasing profits and cash flow. During their first year of ownership, most new business owners see revenue increase 15% to 30% – a result of new energy, different skills and the assistance and support of the previous owner. The focus needs to be on long-term growth. Typically, increasing profits requires increasing sales leads, improving the conversion rate and increasing the number of transactions per customer, the average sale value and the margin on each sale. Can one or more of these areas improve? To determine this, many aspects of the business need to be assessed, beyond the financials and legal diligence.

due diligence typewriter

Will the business meet your needs?

You need to confirm that the business can generate sufficient cash flow to support you, do the debt servicing to pay for the business over a reasonable period of time and provide a return on invested capital. If it’s falling short, you should have some changes in mind to ensure it meets these needs in the future.

Assess the market – its size, desires and how it is being approached. The level to which the business’s product or service is currently accepted may not be indicative of the future. We recommend surveying present satisfaction and future purchasing intentions of existing clients. Sellers who haven’t tested sometimes misjudge and misrepresent.

Is there a future for the product or service? Changes in population, lifestyle and trends, legislation, interest rates, and economic fluctuations and so on have to be considered. Can we improve leads, conversions and volume of sales? Do we have the right salespeople and processes, marketing and sales tools, testing and measuring systems? Can pricing be increased? Can costs be reduced? Do the changes require additional capital investment? If so, is there sufficient capital or credit for these changes?

The first six months

For the first six months of ownership, it’s recommend that the new owner operate the business the same as the previous owner did. Retaining current clients, skilled staff, existing supplier relationships, and the confidence of the marketplace is important. Your experience over the first six months will give you a better understanding of the systems and processes already in place, and form a basis for benchmarking any changes you may wish to make.

Systems, combined with the competence and attitude of the employees who operate those systems, are at the core of most good businesses. You will be able to review both during due diligence. While the need for confidentiality makes it hard to assess employees before closing the purchase, you can learn a lot about them from the current owner, from seeing how they are currently performing, and from your customer survey. You should review the files the business has on each employee, as well as HR systems and policies.

You also need to assess their technology. Is it adequate? What can be improved? Review the existing facilities and related agreements including leases, maintenance, warranties, current suitability, expansion potential and future options. Are licenses and permits current and transferable? Are furniture, fixtures and equipment serviceable? Can they support the business in the future? With equipment, technical and economic obsolescence is an issue – sometimes a perfectly good piece of equipment should be replaced by a newer model with lower operating costs or better features. A knowledgeable technician can help make these assessments.

The original version of this text was published in the book Insider Tips on Buying a Business in Canada. Visit one of our offices across Canada for your free print copyOr, you can download a pdf copy of the book.

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