When buying a business, “due diligence” refers to the process of reviewing all of the available information related to that business. The goal of due diligence is to make sure that all legal and financial issues pertaining to the business are in order and that there are no unpleasant surprises should you decide to go through with the purchase.
Some of the issues to consider in your preliminary assessment of a business are covered in What to Look For When Buying a Business. Due diligence means digging deeper. You’ll need the help of your business banker, accountant, and attorney to do a thorough job of due diligence.
Due diligence should cover the following:
Finances: Ask for the company’s audited financial statements. Request balance sheets, income statements, and cash flow statements, as well as business tax returns for the past three to five years. You and your accountant should review them with the following in mind:
- Is the business collecting its accounts receivable in a timely manner?
- How much bad debt does the business write off each year?
- Is the business paying its debts in a timely manner?
- What is the business’s profit margin?
- Does the company have any outstanding liens?
Legal issues: Ask for copies of the business’s professional and consulting agreements; insurance policies; licenses and permits; any documents related to intellectual property, such as patents or trademarks; and any documents related to lawsuits the company is involved in. You and your attorney should review them with the following in mind:
- Are the agreements enforceable?
- Does the company have the rights to its intellectual property?
- Is the business adequately insured?
- Are the company’s licenses and permits current?
- Is the company involved in any litigation, and if so, what are the potential risks, costs, and damages?
Employees: Request organizational charts, employee handbooks, employment agreements, wage and salary information, benefits plans, noncompete agreements, and confidentiality agreements. Review them with your attorney, keeping in mind:
- Do any employee policies put the business at risk of lawsuits?
- Are there any ongoing grievances with employees?
- Are employees attempting to unionize, or is a third party trying to unionize them?
Business structure: If the business is a corporation, ask for a copy of its corporate charter and bylaws as well as all minutes of meetings held with the board of directors and/or shareholders. Have your attorney review this with you, considering:
- Is the business in compliance?
- Is the business structured properly for your growth plans, or will you need to change its structure?
- Will you need to buy out shareholders, and if so, what will that cost?
Operations: Ask for a list of customers, lists of suppliers and vendors, and an operations manual. Review this information while considering:
- Does the business have adequate inventory systems in place?
- Is the company’s supply chain diversified so that the business isn’t overly reliant on one supplier?
- Is the company’s customer base diversified and growing?
- Does the company have necessary equipment and infrastructure in place for continued growth?
At the end of the due diligence process, you should have a clear picture of where the business is today, where you can take it in the future, why the owner is selling, and whether the asking price is fair.