Doing Due Diligence

Have you heard the phrase "due-diligence" used when a company or a business is for sale and wondered what was happening?

  Due-diligence is the process of investigation by a purchaser together with their legal and accounting advisors before agreeing to proceed with a business purchase.

  "Doing due-diligence" is just as important when buying a one person business, as it is when buying a multi-million dollar one. Whether it is large or small, the same things need to be checked out, but it takes more time with a larger business.

Why are they Selling?

  There is good reason to find out why the business is being sold. One of the first questions to ask is "Why is it being sold?" Reasons can be many and varied; retirement, looking for a change of scene, wanting to concentrate on another business, are just some. However, if it is because the business has reached its full potential and cannot be further improved, or there has been a change in the marketplace, or some similar motivation, then you need to take this into account when considering the price.

The Premises
  An important aspect of the due-diligence process is the premises. Where is the business located? Is it necessary to preserve those premises as an essential part of the business? If so, then you need to look at the terms of the lease and ensure you can continue to operate from them. Timing of rent reviews and other renewals are just two points. With this and other issues that I have referred to below, your solicitor can help you with suitable clauses in the agreement to give you time to investigate these.

  Apart from the lease, other aspects of the premises need to be considered. There are many regulations and laws governing the operation of different businesses. Some of the regulations are administered by Government Departments, others by Local Authorities. It is important that all of these are checked out, such as zoning under the Resource Management Act, occupational safety and health requirements, food and hygiene regulations, or requisitions for work that needs to be undertaken to bring the premises up to standard. Staff can make or break a business, and are a very important factor. Who are they and on what basis are they employed? Do you want to keep them on? Their employment contracts are important.

Financial
You need to know how much money the business is making and will ask for a set of accounts. These can often reveal a lot, but it is important that you not only see the last set of accounts, but also for previous years as well. These will show any trend in the business. It is an area where both your accountant and solicitor can be of assistance to you.

The information is very important when you approach your financier for a loan. Your financier or bank wants to ensure that you are able to repay the loan and on what basis it can be repaid. The budgets which will be prepared by your accountant to show this, will be based on figures revealed by these accounts. They will indicate how the business is financed and what working capital you are likely to require. Once again your solicitor and accountant can be of assistance in this area.

The Customers
  Who are your customers? Will you lose any of their business on a change of ownership because of some personal relationship that customers have with the vendor? Are there some sales that do not come through the door? Similarly, you need to see who your suppliers are. Is there any special relationship in respect of those suppliers which will end once the vendor sells the business?

  These special relationships for either your customers or suppliers could fall into any number of categories. They could be companies or businesses owned by the vendor or vendor's family with whom he is dealing. Special arrangements with friends or people who only want to deal with the vendor are another possibility. There could be special discounts which you need to know about.
Know The Business

  The agreement for sale and purchase should also include a clause requiring the vendor to provide you with assistance for a specified period. You will need to acquaint yourself with the business and become familiar with it. The vendor can introduce you to the customers and to the suppliers.
 
Summary
  The matters outlined above are just some of those things that need to be considered when buying a business, and in carrying out the due-diligence process on that business. Large companies spend a lot of time in planning the process that they will go through in checking out a business that they are going to purchase. They use their solicitors and accountants both in preparation of the checklists, and in carrying out the checking. The process is a time consuming one, but very interesting things can be revealed.

  When you are looking for a business to purchase, your real estate agent or business broker will be able to help you in locating businesses of interest to you. Once you locate the business that you think is right for you, you will want to prepare your offer for the purchase of the business as soon as possible. However, by consulting your solicitor for suitable clauses to be inserted in the agreement, you will be given the opportunity to carry out the necessary investigations before making the contract unconditional.

  Even if problems regarding business are revealed during the investigations it is likely that you will still want to proceed with the purchase. However, you will be prepared and will also have the opportunity to amend your offer.

And that is what due-diligence is.