Due Diligence

The layman’s definition of due diligence, for those of you who are new to the business-buying process, is the period after you and the seller have reached an agreement when you will have access to all of the company’s books and records to thoroughly dissect all components of the business and validate what has been represented.

An effective due diligence goes way beyond the financials!

It is the time for you to investigate the competition, contracts, legal issues, leases, the assets, the core business strategy, looming threats, and key employees, amongst other issues.

Naturally, the business itself will dictate the depth and time required to complete your review. After all, investigating a pizza parlor will be far less comprehensive that a fifty person manufacturing company.

It is a long-standing belief that time kills all deals. While quite often it is the case, this leads to the philosophy of many sellers to push for the shortest due diligence period possible, and of course you want as long as you can. Let your common sense dictate but negotiate the time-frame that makes sense for you to properly conduct your review.

While there are no hard rules, if you have done your research, and prepared yourself properly, even the most complicated small businesses can usually be analyzed in twenty working days. I get flak all the time from sellers arguing this point, but you have to stick to your guns. Conversely, a more simple business with financials, a lease, and some basic legal issues can be done in less time.

In the nine companies I have sold, I have always allowed the buyers as much time as they needed within reason of course, because once I had a contract in place with them, I wanted to get to the finish line.

Above all,

don’t be bullied into an impossible time frame, and make sure that through to the end of this period you can rescind your offer, and get any deposits returned in full, for any reason whatsoever, at your sole and absolute discretion.

Your goal during the due diligence period is to do an effective job so you can close the deal. Your approach should be to prove what the seller has represented, and not just look for a way out of the deal.

If you go into due diligence solely with the agenda to find enough problems to sabotage the deal, save yourself the time and money, and walk beforehand, because you can always find reasons not to buy.

There are some purchase agreements floating around that provide for the forfeiture of your deposit, and deem it to be an “accepted” review, if the revenues/profits of the business are within 5% of what the seller has represented. Never, ever agree to anything like this clause! What if, for example, the financials are correct, but you uncover that one customer represents half of the sales? Or, you discover that there is pending legislation that could render the business obsolete, or severely impact its margins?

Do not allow anything to bind you during your review. This is the last step in the buying process – you must to be confident you are making the right decision.

Since your time is limited, one of the single biggest mistakes buyers make is to leave their entire review to this stage alone. To avoid this plight, from the time the business becomes of interest to you, until you reach an agreement, you should be evaluating all of the key components to the best of your ability with the information you have available.

A good habit to get into is to keep a running list for every business of all of the due diligence items that need to be covered later on. Whenever an issue comes up, just note it on your list so that you won’t overlook it down the road.

You should also be aware that the financial review is usually a lot shorter than you would expect. With good records, and properly prepared documentation from the seller, your accountant can complete their review within a few days usually. On this point, before you start the clock, you must submit a list to the seller from you, your accountant and attorney of all the documentation you will need. Take a day to go over the files yourself before you bring in your team. This way, if anything is missing, you won’t be paying big hourly fees only to learn they cannot complete their review. Plus, if the information doesn’t make sense to you; chances are it won’t to your advisors either.

On of the most important factors to an effective due diligence is to separate any surprises that you uncover into what I like to call “incidents” or “catastrophes”.

Unless you discover a massive issue, don’t run back to the seller with every issue. Keep a running list and complete your work. Then, you can make an effective assessment of the core issues, and decide how to address them, if at all.

Every business has warts. If you don’t uncover any, you probably haven’t looked hard enough. But warts on their own may not be any reason whatsoever to consider renegotiating, or walking from the deal.

Those may just be “incidents” which in the grand scheme of the transaction, and certainly related to the balance of the business, just make sense to overlook and get on with closing the deal.

If you to read some of the typical ask the expert questions we have received on this subject and others click here


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