7. Due Diligence – How to Uncover Any Problems BEFORE You Buy
Due diligence is probably the most critical stage in the buying process. Many prospective buyers incorrectly identify this period as strictly a financial review, but it goes far beyond that. Due diligence encompasses a far-greater project ̶ the complete investigation and review of the business.
One of the keys to buying a good business is your ability to learn the business’ intimate details ̶ to identify the strengths, weaknesses, pluses, minuses, growth opportunities, and areas of concern. If you do not do a flawless job of gathering information, you will not be able to pull the trigger and complete the transaction since you’ll be uncertain about too many components of the business.
When to Start the Due Diligence?
The investigation process must begin the moment a business becomes of interest. Naturally, your goal is to make certain that you uncover everything about any business BEFORE you buy it. You don’t have to meet the seller or even visit the business for your research to begin. The Internet is an incredible tool that will allow you to investigate the business, the industry, the competition, the marketing, the suppliers, and so on.
The importance of beginning your investigation early on cannot be emphasized strongly enough. This way, you’ll position yourself to ask the proper questions to the seller. Once you advance to the stage of an accepted offer, you will start the inspection or financial due diligence. This period usually lasts 10-30 days. This is the time when you’ll have access to all of the company’s books and records.
Once you begin looking at a particular business, you’ll have a thousand things crossing your mind regarding the acquisition. Keep a notepad handy at all times, and log your thoughts. You’ll have many thoughts about things “I need to check out.” Write these all in one place. Don’t trust your memory; these little things are the ones that can come back to haunt you down the road. Begin to put together your checklist of what you need to investigate and how you’re going to do it, along with the materials you may need from the seller to accomplish it.
A couple of things to keep in mind:
1) Allow yourself enough time.
Many sellers and some brokers will press for a very short inspection period; sometimes just days. Don’t get bullied into this – give yourself ample time to complete this part of the process. You should allow for, negotiate, and not settle for less time than you comfortably need to complete a thorough inspection/due-diligence period. The financial review can usually be done in days, but there is more to investigate and that is why a 20-business-day period is not unreasonable for larger businesses, while a 15-day period is needed for smaller ones in order to complete the review and move the deal forward to closing.
2) Prepare properly.
Since you’ll have some time restrictions (you’ll only have x number of days as stipulated in the contract), provide the seller with a list of all the materials required by you and/or your CPA to complete this exercise. No matter what you’re told, do not begin the process until they have provided what you/your CPA need to properly complete the review.
3) Dealing with surprises
You’ll probably find some surprises; don’t panic, it’s normal. Work through them. Get clarification. Build your case. Don’t run to the seller or broker every time you find an inconsistency between what you’ve seen versus what you were told. No business is perfect. The rule to follow is do not treat any incidents as catastrophes or any catastrophes as incidents. If you find a major problem, get your facts in order, and you can then decide the appropriate action to be taken with the seller (i.e. renegotiation, walking from the deal, etc.)
Many buyers have a shy attitude about the buying process, especially generated by uncertainty. If you have not gathered the right information or failed to investigate the business thoroughly, you will not be 100% certain of what to do. And so, you’ll drop the project. Conversely, if you do a flawless job of investigating the business, and everything else adds up right, then making the final decision is simply one more step in the process!