Do the Due: The Importance of Conducting Due Diligence in a Business Purchase

Purchasing an existing business can be a substantial outlay of resources including time and money. Just like you would take a used car to the mechanic to have it checked out before you buy it, you should always do your due diligence on the business that you are looking to purchase. But how exactly do you do that? You’ll need to do a lot more than just kick the tires. Here are some things to look at and keep in mind.

Financial Status: You should ask for and then review very carefully the financial documents of the business including audited financial statements, cash flow statements, tax documents, and balance sheets for at least the last three years and preferably for the last five. Have your CPA or accountant – your financial mechanic – go over them with you to determine if the business is in good financial health. Things to look for including how much is being collected in accounts receivables, if the accounts payable are behind, the amount of bad debt that is written off each year, the amounts and status of any outstanding loans or liens the business might have, and the profit margins for those years being reviewed.

How the Business Runs: It’s important to look at how the business is operating on a day-to-day basis. Are orders being fulfilled in a timely manner? Are there sufficient supply chains in place with back-up provisions to ensure the business is able to meet customer demands? Has demand grown over the past five years? Are there a few large clients, a lot of smaller clients, or a mixture of both large and small clients? What is the projection for the growth of the business in the next few years and is the business in a position to handle that expansion?

Employment Issues: Employees make the business work and so you should pay particular attention to issues such as retention, or how much turn-over the business has in employees. Some industries have high-turnover as a part of the business while others do not. Are there any pending issues with current employees that may develop into litigation down the road? Are there any unions or attempts to unionize? Are employees motivated and excited about working there?

Legal Questions: Just as the financial side of the house needs to be in order, so does the legal side. Issues that can present themselves here are whether there is pending litigation against the business already or any threatened litigation on the horizon. Is the business current on its tax obligations and licensure with various state and federal agencies? Does the business have sufficient insurance coverage, employment agreements including non-disclosure agreements or non-competition agreements, and ownership of its intellectual property? Does the business have employee manuals setting forth company policies on a range of issues?

Other important questions to ask are, why is the business being sold? Is the person who made the business what it is and is the linchpin in the organization also leaving? If so, what does that mean for the future of the business? What assets are coming over as part of the sale? If the intellectual property is not part of the sale – perhaps it would be licensed to the new owner – would this have a detrimental impact on the value of the business?

If you are considering purchasing a business, it is vital to have competent and knowledgeable counsel assisting in the due diligence process so you can know exactly what you are buying and getting into. Consider contacting the experienced team at Trembly Law today for this important undertaking.