Question:

What are the things I need to be aware of when I get to the due diligence stage of a business? I am very comfortable with financials so do I really need a CPA and what else is involved? Right now the seller and I are far apart on the price; do you have any recommendations? His accountant and mine disagree completely on the valuation. I would appreciate your input.

Answer:

This is an excellent question. The due diligence stage of any business purchase involves far more than the financials including a thorough investigation of the assets, contracts, customers, suppliers, competitors, employees, the systems, sales/marketing plan, and legal issues.

The CPAs Role:

Regarding a CPA my answer is a resounding “yes” to have one involved in the process although they will, for the most part, contribute in the financial review aspect only.

One thing that you should do is review the seller documents first, prior to your CPA ¬ñ if they don’t make sense to you, chances are they won’t to the CPA either.

Also, be sure to engage a CPA who is familiar with the type of business you are reviewing.

What to investigate:

There are typically eleven key areas to review in a due diligence as noted above. Interestingly enough a thorough due diligence review requires you to investigate about 200 individual issues. It’s critically important that you organize yourself properly for this stage and getting the seller to comply with your document requests should be your first priority. Compile a list with your CPA of what is needed and my recommendation is that you do not start the clock until you receive all, or substantially all of the documents requested.

The goal during due diligence is to uncover any potential problems before you buy the business.

As with any business, you will find some issues and surprises and that’s ok. Try to separate incidents and catastrophes.

Additionally, your goal should be to validate everything that the seller has represented about the business. Some buyers go into this phase hoping to find problems so they can renegotiate. While some uncover serious flaws, most don’t but in looking to nitpick every minor issue, they end up sabotaging the deal. As such, be thorough; actually, be flawless but don’t be taken aback if/when you uncover a problem because you will find them. Keep articulate notes and decide at the end whether or not a renegotiation is necessary.

Bridging the gap on price:

It may make sense for you and the seller to engage a neutral third party to perform an appraisal on the business as well. This may assist both of you to narrow the gap on the price or to at least gain an understanding of what drives the valuation process.

Should you decide to go this route, be certain to use a certified business appraiser and not a CPA. A professional appraiser understands the market for business sales, while a CPA usually attaches a value that may make sense theoretically, but may not reflect market trends, or it can be too much of an asset based valuation whereas small businesses are sold based upon Sellers Cash Flow, and there’s a huge difference. The only issue I have with appraisers is when they try to impart big business valuations on small business transactions. In general, my experience with appraisers has been positive and it may be an avenue for you to consider.

Above all – take your time.

No matter what, take the time you need to do a proper job inspecting the business. Regardless of what pressure you get from the seller, you need ample time. I work as a business broker and I get into many confrontational issues with other brokers when they try to limit the due diligence to five days.

The fact is that it’s absolutely impossible to complete a thorough due diligence in five days.

Please understand that you can easily complete the financial review in five days. In fact, with good books and records, your accountant can complete this even quicker. However, a successful due diligence and inspection period goes way beyond the financials. When a buyer is rushed, it leads to uncertainty which leads to deals falling apart (it’s probably why approximately 50% of all deals agreed to between buyer/seller never get to the closing table, according to industry insiders).

The rules to keep in mind for a successful due diligence are:

• Organize and prepare yourself properly
• Engage a competent CPA (an appraiser where necessary)
• Make certain the seller provides the necessary documentation
• Attack this in a methodical manner. Prepare properly.
• Log all of your To Do’s.
• Work with a detailed checklist of what needs to be covered
• Negotiate ample time to complete your review
• Follow the quote I once read by McClean: “Don’t treat any incidents as catastrophes nor should you treat any catastrophes as incidents.”

When you encounter a problem keep a record of it. If you are faced with having to renegotiate, you’ll only be successful if you have adequate proof that the business is not worth what you and the seller had previously agreed to.