When buying a business it is important to find a business that is the right fit for you. Do your due diligence before even making an offer. Due diligence defined is the process of researching and analyzing a potential investment to determine its health and value. Due diligence involves reviewing financial statements including tax returns, inventory, furniture, facilities and equipment, contractual obligations, employees, marketing and advertising, the business’s reputation, and lastly the exit strategy. Sometimes due diligence is a legal obligation for some transactions but if it is not it is a recommended step in deciding whether or not to purchase a business. Let’s further examine the due diligence process.
It is necessary to examine financial statements including tax returns when doing your due diligence. The financial statements give you an overall snapshot of the company you are considering buying. You want to look at minimally the last five years of financial statements. I recommend having a professional Accountant review these documents to ensure everything adds up.
Financials are an in important part of due diligence but there are many other areas that need to be investigated.
Inventory. Not all businesses will have inventory but if the company you are examining does, be sure to take a detailed look at the company’s inventory. Ask the current owner if you can take part in taking the physical inventory. This will show you what is actually on hand and if any items have been sitting around for a long period of time. Ideally you want inventory that is less than three years old. Inventory will be a factor in how the company’s owner prices the business. Looking at the inventory yourself can help you figure out if you are paying a fair price.
Look closely at the furniture, facilities and equipment as they are all also factored into the price of the company. Is everything up to date, will it need updating, repair or replacement? The answers to these questions will help you negotiate a purchase price especially if work needs to be done. Getting estimates on what it will cost for upgrades can further aid in negotiations.
Concerning contractual obligations including vendor and utility agreements, it is important to review copies of these agreements so you have a clear idea of how long you are tied to anyone agreement and what penalties you are obligated to pay if you exit the agreement.
The company’s employees are such an essential part of buying a business. You need to find out what type of team you are working with. You want to know which team members you’ll be able to rely on during your first months on the job. You also want to know who will most likely be your “problem child”. I recommend talking with the current owner about the team and get the inside scoop on each of the employees. Asking to see resumes from when they were hired can also be helpful.
After you have reviewed the financial statements, you should know what the company’s marketing and advertising budget is. So, you’ve got the number but do you know what the company’s marketing strategy is? Consult with the current owner on his/her marketing strategy. Find out who handles marketing functions-the owner, third party vendors/agencies. Once you have all this information, you need to decide what your strategy will be for this function. If the current owner is spending ten thousand a month on advertising you have to decide if you are going to be prepared to do this after buying the business. If not, be sure to anticipate how this change may affect revenue.
Reputation. Ideally you want to buy a business that has a good reputation throughout the community. If you are buying a business that people have a bad perception of then you are going to have to work to reverse that and rebuild the company’s reputation. Ask around and see if people have heard of the company and if so, ask them what they think about it.
Lastly, look closely at the owner’s exit strategy and make sure you are going to be given adequate training to take over the business. You also need to determine what impact the owner leaving with have on client and vendor relationships. Also, ask the owner to identify key employees that can help through the transition.
Doing your due diligence is time consuming but it is critical in making sure that you are investing in the right company. Doing a thorough investigation upfront can save you time and money in the end. My advice…do not skimp on due diligence and hire a professional to help you through the process!