Due Diligence When Purchasing a Business – Part One

The process of investigating a business for sale is commonly referred to as “due diligence”.  In layman’s terms, “due diligence” is essentially the exercise of common sense, and it is the difference between the beginning of a successful venture and a complete disaster.  Proper due diligence requires a thorough evaluation of the company’s business, its history and its finances, and it is best conducted with the assistance of a team of professionals including a lender (or lenders), an appraiser, an accountant (preferably a CPA) and a lawyer.  

81261_modecore.jpg“Due diligence” starts with an understanding of the industry.  It’s important to learn as much as possible about the industry’s fundamentals including operations, manufacturing processes, suppliers, current and historical markets, customer preferences, local and national competitors, marketing methods and anything else relevant to the industry.  Wise purchasers look for businesses where they have an aligned interest or expertise.  Once you have a clear picture of the industry you can better evaluate the specifics of the prospective purchase.  

The next step is to examine the business for sale, starting with its financials.  This is best done with the assistance of an accountant.  The review should include an in depth analysis of the company’s records including but not limited to its current balance sheets, profit and loss statements, financial audits, accounts payable and receivable, debts (secured and unsecured) and information pertaining to any liens on debt, and the company’s tax returns for the past five years.  Check, or have your attorney check, with the County Recorder’s office for undisclosed liens and UCC-1 filings (filings made by creditors with loans secured by the company’s assets).  Ask the following important questions:  What does the revenue stream look like?  How has it changed over time?  How about expenses?   

In addition, inspect the company’s physical assets including equipment and inventory.  If uncertain about the condition of equipment, consider inspection by an expert.  For instance, it’s probably a good idea to have a certified mechanic inspect a fleet of delivery trucks.  Ensure that the inventory is in good shape, current and marketable.  Include an inspection of the office furniture, equipment and supplies.  It’s best to know in advance if you are investing in obsolete printers, copiers, software or other leading technology.  Moreover, you can tell a lot about a company based on the condition of its office or offices.  Consider the companies intangible assets including copyrights, patents, trademarks and trade secrets.  Talk with the company’s customers, vendors, suppliers and even its competitors about its reputation, and contact the Better Business Bureau and other industry associations.  Finally, conduct an internet search for reviews.  Sites like Yelp.com offer insight into the business’ goodwill in the community.  

Continued in The Necessity of Due Diligence When Buying a Business – Part Two.

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