Due Diligence and Buying a Business
You have found a business that looks great but you want to make sure it is performing as well as the Seller claims. It is time for due diligence!
Most of the time, a Seller will not give you all the details and documents you wish unless you are under contract to buy the business. From the Seller’s perspective, providing you all the documentation can be a very sensitive issue. Additionally, it can take the Seller a great deal of time and money to provide all the documents you will need, especially when they have to get their accountant and other professionals to help round up the necessary information.
You, however, may wish to confirm that the information being conveyed by the Seller is accurate before you make an offer. What you discover in your research might even affect the price you offer. Sellers usually won’t give you much information until they are sure you are serious and are ready, willing and able making an offer they can live with. Often the only way to verify the quality of the business and its financial records is to make an offer in writing.
Here are a few key things to keep in mind.
When making an offer, give yourself an out if the records don’t support your expectations. In your offer, add a contingency stating that, if for any reason you are unsatisfied with your Due Diligence, you are able to withdraw your offer and receive all escrow deposits or other funds back without hesitation. You may want to get the help of an attorney for drafting this contingency. The Seller may insist that you to be specific about your expectations and ask you to modify the contingency; i.e. “if 2017 annual revenues show more than a 3% negative variance…” or “if Seller’s Discretionary Earning are less than $105,000 for last full operating year…” This contingency will give you a way out, but if you still like the business but only at a lower price, you now have a chance to renegotiate.
Deposit with Neutral Professional
Make sure that if a deposit is required, and it usually is, that the funds are invested with an independent source and not deposited into the Seller’s bank account. Some brokerages hold the escrow themselves, but consider using an independent escrow agency or attorney.
In the Asset Purchase Agreement, detail how long you will need to prepare a list of items for Due Diligence. If possible, provide the Seller with your initial list at the time of, or right after, your offer is accepted. Include how long the Seller will have to get all the documents to you, and how long you will need to finalize Due Diligence after you receive all those documents. Give yourself ample time and take holidays and weekends into consideration.
Most of us make better decisions with the help of an experienced professional who understands privately owned businesses. You might want an accountant to review financial documents and an attorney to review contracts and leases. Long before making your offer, find trustworthy professionals who have time to help you. Confirm that they will be ready, willing and able to help when you need them. Make sure these professionals have solid a solid understand of, and experience working with, small businesses like the one you are considering.
What is a 4506T?
Often you will be looking at tax returns as part of your Due Diligence. Having the Seller sign a 4506T allows you to request a copy of the tax returns that they submitted to the IRS. We have seen more than one occasion when the Seller “got confused”and presented a prospective Buyers with draft of their taxes, signature and all, that significantly differed from the copy that the Seller submitted to the IRS.
Make A Great Due Diligence List
Appropriate Due Diligence lists differ depending on the industry and the particular business specifics. Some have leases, some are franchise, some have client contracts, some have supply agreements, some have work in progress… Sit with your advisory professionals to generate an appropriate list. You can request a generic one from our firm to use as a starting point, but make sure you craft one that will be appropriate for you and the business you are investigating. Resist the temptation to download one from the internet that has a long list of items that do not apply to the business you are researching. Long lists of unnecessary items frustrate that Seller, complicates the process for you, and wastes valuable time whittling away the unnecessary items. Be focused and respect the time of everyone involved, including yourself.
Keep to the Time Frame
Once your offer has been accepted, your Due Diligence Clock usually starts ticking. Outline the schedule on a calendar and keep to. If the business fails to pass your Due Diligence, follow the contract terms within the time frame specified. If you need more time, get a mutually agreed extension in writing. Failing to complete and comply with the Due Diligence contingency can lead to serious legal challenges you should avoid. Remember – always seek professional support whenever you are uncertain about any part of the business acquisition process.
Good luck. I hope these tips help you.
If you have any questions about the buying process or if would like a copy of our basic Buyer’s Due Diligence form, please email me at info@BuyBizUSA.com. In your message, tell me to “Please email me a copy of the Buyer’s Due Diligence form.” Please make sure you include your name so we can get it out to you.