7. Due Diligence – How to Uncover Any Problems Before You Buy
Due diligence is probably the most critical stage in the business buying process. Many prospective buyers incorrectly identify this period as strictly a financial review, but its importance stretches well beyond that. Due diligence encompasses a far-greater spectrum of activities, as it is a complete investigation and thorough review of the business.
One of the keys to buying a good business is your ability to learn as much as possible about the business’ intimate details: the strengths, weaknesses, pluses and minuses, growth opportunities, and areas of concern. If you do not do a flawless job during the due diligence period, you will not be able to pull the trigger and complete the transaction, since you will feel uncertain in regard to many components of the business. When to Start the Due Diligence?
The investigation process must begin right in the moment a business catches your interest.
Naturally, your goal is to make sure that you uncover everything about the company, before you buy it. You do not need 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 company, the industry, the competition, the marketing, the suppliers, and any other aspects you feel are important. The importance of beginning your investigation early on cannot be emphasized strongly enough. This way, you will create the advantage of questioning the seller on appropriate topics.
Once you advance to the stage of an accepted offer, you will start the inspection or financial due diligence. This period usually lasts between 10 and 30 days. This is the time when you will have access to the full company history, books and records. Once you begin looking into a particular business, a thousand things regarding the acquisition will be constantly in the back of your mind.
Keep a notepad handy at all times and log your thoughts, especially those along the lines of “I need to check out/find...”. Do not trust your memory; these little things are the ones that can come back to haunt you down the road. Fill the checklist with all the resources you need to complete this investigation, the modalities and sources of information, as well as the means that the seller must make available to you during the due diligence period.
A couple of things to keep in mind
Allow yourself enough time
Many sellers and some brokers will put pressure on a very short inspection period; sometimes just days. Do not 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 are far more aspects to investigate. Hence, a 20-business-day period is not unreasonable for larger companies, while a 15-day period should suffice for smaller ones.
Since you will have some time limitations, provide the seller with a list of all documents and resources necessary for you and/or your CPA to complete this exercise. No matter what you are told, do not begin the process until you have been provided with what you/your CPA need to properly complete the review.
Dealing with surprises
You will probably find some surprises; do not panic, it is absolutely normal. Work through them. Get clarification. Build your case. Do not run to the seller or broker every time you find an inconsistency between what you have found versus what you were told. No business is perfect. The rule to follow is to 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 during the buying process, generated especially by uncertainty. If you have not gathered the right information or failed to thoroughly investigate the business, you will never be 100% certain that the investment is safe. And so, you will most likely drop the project. Conversely, if you take the time to properly investigate the business, making the final decision is simply one more step in the process!