Due Diligence

I received some great comments from last week’s article and I truly thank you for your feedback. Regardless of where people sit on the political front, it seems there is overwhelming agreement that the recent economic stimulus programs, and the ways in which they were derived, have really upset a lot of people and most think they are going to be ineffective.

I am still on the fence over all this activity. While I do believe many of these programs have been completely misguided, and done without thought, and I would personally like to impeach some of the morons in Washington that devised these plans, I am taking a “wait and see” approach. It’s probably because I hope some take hold and get help to where it is needed, but I am not confident that it will. We’ll see.

Today I want to discuss suppliers, and how to deal with them when buying a business.

It is common to find businesses where a disproportionate amount of there revenue is generated from one source of supply. It is similar in fact to customer concentration issues.

Business buyers often cannot gain any comfort unless they are assured that this supply source will continue at the same terms and conditions after they take over.

And so, it is natural, and reasonable, for a buyer to want to meet with any such suppliers prior to closing a deal. Conversely, it is a relationship that many sellers may not want to expose because of their fear of losing this relationship if the deal does not materialize.

While both arguments make sense, it can be a deal-breaker. So here are six things to keep in mind:

1. Suppliers generally have one agenda – to sell their wares. Unless there is a compelling reason to do otherwise, chances are they will continue to supply the business. However, a buyer cannot simply make this assumption.


Meeting with key suppliers has to be done as part of a buyer’s due diligence but in order to provide the seller with ample comfort it should be one of the final deal conditions to be met, after you have “signed off’ on other deal contingencies.

3. Don’t expect to negotiate better sales terms with the supplier. Your initial objective should be to guarantee that you can buy from them at the same terms and conditions as the current owner.

4. Buyers have to understand that most suppliers will not give you an ironclad contract and it may be that there is no contract at all with the supplier and seller. Typical agreements, if they even exist, have enough room for a supplier to drive a truck through. They will usually allow the supplier to stop selling you at their discretion with little notice and so you need to have the mindset of being comfortable with this type of arrangement.

5. Having one key source of supply is dangerous – make no mistake about it. And so you need to also investigate the options to increase your supply base as part of your analysis. Operating a business with multiple vendors is just common sense.

6. If the business has a great dependency on one or few suppliers, there should be an earnout clause that ties an appropriate percentage of the purchase price to the retention of the supplier for a certain period of time after the deal closes. Keep in mind however that the seller cannot bind the supplier, but a buyer can bind a seller to certain issues being sustained or materializing after the sale in order to justify the purchase altogether.

I have owned businesses that relied on a limited number of key suppliers. It was usually a situation that evolved over time, and both parties brought “need” to the relationship which solidified it. In other words, there was a risk on both sides if the relationship ended, and so it usually worked out well.

It is easy to say you should never have all your eggs in one basket, but sometimes that is the only option. If that is the case, then you had better be certain you take really good care of the eggs and have a deal in place that eliminates your exposure in the event they get scrambled.


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