Due Diligence

Continuing last newsletter’s subject of the due diligence stage of a business for sale, this edition we will discuss how to separate minor issues from major ones, what if a buyer has to renegotiate the deal based upon their findings and how to conduct a thorough review given the concerns every seller has about due diligence.

There are always issues and problems with every business for sale as there is no such thing as a perfect business. Actually, there is: it’s the one no buyer has been able to find yet but believes it exists. Anyways, sorry to digress, let’s get back to the discussion on due diligence when buying a business.

How to Separate Minor Issues From Major Ones

This is a huge aspect of the due diligence process. In my experience, it is one area where inexperienced prospective business buyers really get stuck. The due diligence phase is one step closer to the finish line, and fear starts to creep in as an individual begins to realize they may soon in fact be a business owner. They may begin to second-guess their decision and therefore every minor issue gets magnified. My rule has always been to step back and separate problems into one of two categories: incidents or catastrophes. I have discussed these in the past and the key is to understand the difference between the two, and above all, do not treat any incidents as catastrophes nor should you treat any catastrophes as incidents. In other words, focus on problems that arise that significantly impact any part of the purchase deal, or ones that can change the entire business in the future.

Every business has its warts.

If you avoid buying a business because of the odd minor issue, you will never complete a deal.

Incidents can be a slight variance in the financials, or a minor decrease in customer count, or the inventory levels are not spot-on as originally represented. These can all be dealt with easily.

However, one must never, ever overlook major issues that are discovered and these have to be deal with effectively; the ones I call catastrophes.

Examples of these can be a huge discrepancy in the financials, customer concentration issues or the non-renewal of contracts or licenses to name a few.

Renegotiate or Walk?

The goal of due diligence is to conduct a thorough and complete review and thus the best strategy is to complete the process before approaching the seller with any major issues which necessitate a discussion or possibly a renegotiation. Obviously, if a buyer discovers something that is beyond reconciliation then of course you would want to abort or halt the process earlier.

Keep a log of all issues that are discovered during the review. Then rank them as either (i) deal breakers, (ii) concession needed or (iii) talking points. Alongside each of these three categories (and especially items one and two), list how you want to resolve them. Then, meet with the seller and go over them. It is always helpful to start the discussion with: “overall I am pleased with the due diligence review but I am not able to sign off on it as there are a few points we need to discuss.”

Keep in mind that when a buyer enters due diligence, most sellers start to see their exit from the business so this sudden change or hiccup can cause them to become disgruntled as you are interrupting or derailing their plans.

Unless you discovered something which is so significant it cannot be remedied and you have to walk from the deal, your strategy should be to work towards a solution. Do not enter the discussions with “guns blazing”. Often times, renegotiating a deal is more tenuous than the initial negotiations. Take your time and explain your perspective in a logical manner backed up entirely with factual data accumulated during your due diligence review.

The Sellers Concerns About Due Diligence

The obvious concern every seller has is allowing a buyer full access to their company with the possibility that a deal may not materialize. As such, there are certain aspects of the business where the seller may not want you to access which can include employees, supplies, and customers. The nature of the business will dictate to what extent these potentially sensitive areas may have to be investigated. Sometimes, they do not need any review and in other cases they are paramount.

For these hyper-sensitive areas, the one solution I have found to be acceptable to all sellers is to address the due diligence in stages. For example, you may want to review the financials first and once those are deemed to be accepted, you can move on to the next area (i.e. suppliers). Once that is completed and accepted by you, perhaps you can next meet the landlord. The idea being to do this in steps so the seller does not have to expose any part of the business unnecessarily and without knowing that the buyer has at least satisfied the previous contingency. This approach allows the parties to build credibility with one another and not put either party in too vulnerable a situation in the event the deal does not ultimately get consummated.

Click here to read more about due diligence when buying a business

Have a great week.

Richard Parker



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