In my last post I described what due diligence is. Here are some stories of due diligence gone astray…
I had sold a business whose business assets consisted of a bunch of heavy equipment related to wildland fire fighting. The equipment was stored in a very remote location in far northern
The deal closed and soon after comes the very first wildland fire of the season, and one of the tractor/trailer units responding to the fire gets a highway safety check by the California Highway Patrol. It doesn’t pass and the unit gets shut down on the spot and can’t move until it’s fixed. It was actually not a major item, but the new owner felt the immediate impact of not being able to deliver the equipment to the fire on time. Things just went downhill from there between the seller and buyer and now they do not speak to each other.
Sometimes it is difficult to collect the material for due diligence. We had a family run business (around $8 million in revenue) that was literally run out of their house. They were not very organized, so my partner and I showed up with a digital scanner and set up shop at the dining room table (we don’t always get hands-on for due diligence, but sometimes the seller needs help). We went through the buyer’s list and scanned everything we could in three or four hours. Unfortunately, some very important contracts never turned up anywhere, but somehow we managed around that.
It is always good to remember that due diligence is when the buyer gets to examine whether the seller was honest about, well, everything. I’ve had more than one instance where upon closer look, it turns out the assets were worth more like $300,000 than $500,000. Or revenue was lower because of how revenue was recognized. Often the seller isn’t maliciously trying to mislead, they just took a guess – an aggressive one. Sometimes the seller needs to make a price concession after such a discovery, sometimes not.
I’ve also been involved in transactions where the buyer just doesn’t quite get his act together, in the essence of time, closes the deal without adequate due diligence. Even though I want the deal to close on time, this is a little uncomfortable because I know the buyer may not know everything about the business that he needs to.
Which brings me to attorneys and due diligence. Use one. Both a buyer and seller need legal guidance on the risks associated with a business sale and it is usually during the due diligence process where risks are identified and researched. Sometimes it is frustrating for me when an attorney goes a little overboard (or a lot overboard) on the due diligence process, but I know it’s a required process for the buyer and seller.