Due Diligence Guide
30/10/2014
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When you're looking for a business to purchase, there's no doubt of a lot of things you'll want to check.
However:
It can be quite intimidating to work your way through the list of facts to verify and things to consider.
We're happy to tell you that there's no need to worry, since with a little bit of assistance it becomes much more manageable.
We're going to give you advice and tips on doing your due diligence to make sure there's nothing you'll overlook.
What is due diligence?
In a nutshell:
Due diligence allows you to assess the value of the business and the risk associated with it before completing the purchase.
Entrepreneur.com accurately defines due diligence as:
“A reasonable investigation of a proposed investment deal and of the principals offering it before the transaction is finalised to check out an investment's worthiness; generally performed by the buyer’s solicitor and accountant.”
Although due diligence usually consists largely of the review of financial statements and accounts, you should also ensure that you review the condition of stock (if applicable), all contracts, legal documents and anything that directly effects the running of the business.
Due diligence should always provide you with an accurate view of how the business is currently performing, and how the business will perform following the sale.
When should due diligence start?
As previously mentioned due diligence typically occurs following the acceptance of your offer for a business, however you should start investigating a business as soon as you become interested.
Although our team will always look to obtain key financials from the seller, we recommend obtaining copies of the company accounts by using Gov.uk's page for ordering certified copies and certificates.
What to review in due diligence?
In your due diligence consider reviewing many of the following areas of the business:
- Customer contracts and orders
- Financial statements and accounts
- Employment contracts
- Management structure (if applicable)
- Stock (if applicable)
- All legal documents
- All liabilities
- Business opportunities
- The reputation of the business with customers, suppliers and local stakeholders
A lot of these make sense on their own, but below we'll add further explanation to three of the items in this list. This way you're guaranteed to include everything in your overview.
Financial statements and accounts
Ask to see a minimum of three years’ worth of tax returns as well as balance sheets and cash flow statements, though you may be required to sign a non-disclosure agreement before becoming privy to sensitive commercial information.
Check that bills are being settled – and payments being received – regularly and on time and that both profit margins and cash flow are healthy.
Factor in the costs of any bad debts, too.
And don’t overlook sales records – analyse them carefully to discover how the company is performing and whether there are spikes and dips that may correspond to seasonal patterns.
See if your seller is willing to provide figures on the company’s biggest customers (in code, if necessary, to protect their identities) so you can explore buyer behaviour more accurately.
Legal documents
The ramifications of missing an important legal loophole can be disastrous.
For instance:
Imagine if you committed to buying a business without ensuring that the lease on the premises it occupied was transferable.
Make sure you instruct a solicitor experienced in business transactions and check copies of all contracts and legal documents (leases, purchase agreements, distribution agreements and such).
You may also need to verify that the business is adequately insured and that required licences and permits are valid.
If you’re inheriting employees as part of the deal, it makes sense to learn everything you can about the terms and conditions of their contracts.
Business opportunities
Gaining a thorough understanding of your prospective business’s strengths, weaknesses, threats and opportunities is a key part of the due diligence process.
The more you can discover about the business itself, the market in which it operates, areas where there may be room for growth and factors which could stifle it, the more prepared you’ll be for the challenges that lie ahead.
Analyse business operations carefully.
Study industry and economic data to ascertain whether sales seem likely to grow, decline or level out, and consider whether current pricing strategies are realistic.
If your offer includes equipment and / or stock inventory, make sure that their valuation reflects condition, age and market conditions.
Due diligence tips
We're here to help you buy a brand new business.
As such, we're happy to share with you some of the tips we have when it comes to doing your due diligence.
Allow yourself enough time
Don't underestimate the effort due diligence can take.
Due diligence typically takes at least four weeks to complete.
So make sure you plan for at least a month of investigation.
Prepare
Have a full lists of all the areas of the business that you need to analyse (see 'what to look at for due diligence' above before you get started.
Appoint the best people
Make sure that you have your A Team assembled when you are looking to buy a business.
You will need an accountant and a solicitor to help assess the financials and ensure that all legal aspects are water tight.
Handling surprises
It is unlikely that you won’t come across at least one aspect of the business that will surprise you.
Try to analyse the issues objectively and weigh up whether this is an issue that will seriously affect the running and success of the business in the future.
Remember that you can always renegotiate with the seller if you have come across any significant surprises.
Related Guides
We hope that the above has answered some of your questions regarding due diligence and that you're now more prepared to buy a new business.
Want more useful insights and guides? Why not visit our knowledge hub and learn more about buying, growing or selling your business.
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