While there may be many reasons why a buyer wants a particular firm – its location, expertise in a specific area or a lucrative client book – the prospective buyer must do proper due diligence. This process is the most important part of your search and should be initiated at the earliest opportunity and before exchange of contracts or completion of a purchase.
Due diligence is effectively an audit of a firm’s affairs to establish its assets and liabilities and evaluate its commercial potential. It is a vital step when buying a business and will give a thorough review of financial records, legal issues, and the market positioning. It will also look at historical records and future projections, as well as any possible risks that may exist.
Understanding the business
The due diligence process allows a buyer to better understand the business they’re buying into and learn whether the price they have offered is a fair price. If the due diligence process is carried out early on then, it allows you to deal with any issues upfront or hidden liabilities which may have not been disclosed. This information can then be used as a strong bargaining tool to negotiate terms, including deferred payments.
Alternatively, the buyer may be able to seek warranties and indemnities from the seller, which essentially gives the buyer a right to claim a portion of the purchase price back if any of the foreseen problems arise.
There are traditionally three types of due diligence you should do and you might need different advisors for each depending on the type of business you are buying.
legal due diligence – as part of a sales and purchase contract, the lawyers can check that the business has legal title to sell, ownership of all the assets and that regulatory and litigation issues are fully addressed.
financial due diligence – checking the numbers and making sure there are no black holes or hidden financial issues.
commercial due diligence – finding out the business’ place in the marketplace, checking competitors and the regulatory environment.
Below is a checklist of what a buyer needs to cover as part of their due diligence process:
- Corporate information – company structure and any subsidiaries, shareholders, option holders and directors
- Business and assets – business plan, key assets and equipment, material contracts with customers and suppliers
- Human resources – employees, employment contracts, directors’ contracts, salaries and wages, handbooks, disputes, pensions
- Property – properties owned, leased or occupied by the business
- Information Technology and Intellectual Property – software and equipment used, maintenance and support contracts, intellectual property (IP) used or owned by the company, including all license agreements for domain names, website design, trademarks, and copyrights
- Data protection – how data is stored, safeguarded and used, privacy policies and GDPR compliance
- Litigation and regulatory – any disputes the company is involved in or likely to begin, and any licenses or regulatory consents
- Health and safety – any relevant policies, log of incidents
- Insurance – claims history, insurance policies, premiums
- Financial – accounts, assessment of tax liabilities, loans, charges and borrowing, VAT.
Take some time to reflect on what your due diligence has revealed before making your final decision and it will also show you are serious about investing in the firm. Do not, however, try to get stuck in ‘analysis paralysis’ where people find themselves in a perpetual cycle of due diligence, afraid to make a decision.
Some prospective buyers fail to do careful due diligence and end up regretting it later, often having to face unexpected financial shortfalls. Due diligence is paramount as it can uncover risks, anomalies or unforeseen liabilities that could undermine negotiations and ensure you don’t get stuck with a business that has no future. And no one wants to make that mistake.