Buying a business is an exciting step that can lead to financial independence and personal fulfilment. Therefore, when buying a business, you want to make sure you know exactly what you are going into. This means understanding the commercial viability of the business you are going to purchase so that you can make a well-reasoned decision as to whether or not you will buy it. Consequently, you must understand the due diligence process and  what it involves. This article will guide you through:

• the due diligence process;
• how to do your due diligence
• different diligence types; and
• other ways of reducing risk.

What is Due Diligence?

In short, due diligence is a check of various financial, commercial and legal aspects of the company you will buy. This process usually involves reviewing and investigating all relevant business records, issues and assets. You will usually do this check with a due diligence team of professionals such as:

• accountants;
• lawyers who are familiar with selling businesses; and
• business advisors or brokers.

The majority of the due diligence should be undertaken prior to you signing a binding contract such as the sale of business agreement or share sale agreement with the seller/s. However, it can also be undertaken in conjunction with you negotiating and finalising the relevant agreement with the seller. Regardless, ensure that the sale agreement includes a provision that makes the sale conditional on you finalising your due diligence. Without thorough due diligence, you cannot make an informed decision. However, there are also ways to speed up the due diligence process to prevent it slowing down the sale. For instance, you can:

• negotiate the sale agreement in conjunction with conducting due diligence;
• include a timetable in any heads of agreement or term sheet you enter into with the seller;
• negotiate an exclusivity period in the term sheet request information on a timely basis; and
• engage professional advisers to review documents provided by the seller(s) early on.

Financial Due Diligence

Financial due diligence involves assessing the financial state of the company you wish to buy, to decide whether it is in good enough shape for you to purchase. For instance, this could involve requesting business records such as:

• profit and loss statements;
• balance sheets;
• tax retums;
• sales records; and
• business valuations.

These will all assist you in deciding whether or not the business is the right fit for you and your financial goals. If it is not suitably profitable or if the valuation is too high following your review of the financial information provided by the target, you may want to consider passing on the sale.

Commercial Due Diligence

This looks at the commercial viability of the business you want to purchase. This would involve looking at such things as its:

• location (is it in a quiet area or is there a lot of foot traffic? Are there any upcoming development plans, such as rezoning or construction work?);
• competition (are there many other businesses in the same industry that could draw away potential customers?);
• growth opportunities (do you foresee many opportunities for the business to grow and expand rather than stagnate?);
• business suitability (is it in an industry that aligns with your goals?);
• condition of important assets;
• industry (is the industry that your business is in expanding or declining? Does your business have a particular edge?); and
• suppliers (can you continue to use existing suppliers, granting you continuity, or will you need to enter into a new arrangement?).

This will help you understand how the business currently operates and what potential issues could arise in the future.

Legal Due Diligence

You will also want to undertake legal due diligence, largely to confirm if the business is compliant with relevant laws. This due diligence includes looking at:

• asset ownership;
• any contracts currently in place (supply contracts, employment contracts and client agreements);
• if the business is compliant with relevant laws and regulations;
• corporate information about the seller or target company;
• relevant leases (and whether they can be transferred to you through a deed of assignment);
• security interests and financial arrangements; and litigation.

Business Assets

In addition to undertaking financial, commercial and legal due diligence, you should also consider any key assets the business has, such as intellectual property or equipment. In particular, you should ensure that the seller fully owns them so they can transfer or assign them to you. This is critical, as assets such as intellectual property can be immensely valuable to a business. Therefore, you should consider business assets such as:

• trade marks, designs, patents and domain names;
• marketing material;
• business names and whether they are registered;
• contact details such as social media accounts;
• source code for software and websites;
• title to equipment or other physical assets; and
• equipment lease or hire to purchase.

How to Reduce Your Risk

Buying a business will always be a risky endeavour. Even if you are making a well-researched and well-informed decision, there will always be an element of risk – a chance that the business may not succeed, and you may lose money. One way to reduce your risk is to make sure you understand the seller’s motivations and position. By considering:

• why they are selling the business;
• what their role is in the business; and
• whether they could become your competition in the future.

You can assess whether you may need additional training to run the business or if they may have ulterior motives you should be aware of. Additionally, if you uncover significant issues during the due diligence process, you can ask for a reduction in the purchase price or ask that the seller fix specific identified issues before completing the sale.

Finally, you should ask the seller to provide warranties and indemnities in the contract. These obligations require the seller to make specific representations and promises about the business and reimburse you for specific liabilities. Having legally enforceable contractual obligations can protect you from any loss and reduce your risk. You may also withhold a certain portion of the purchase price for some time after the completion of the sale to protect you against any breaches of warranties that may arise.

Key Takeaways

The due diligence process is a crucial step when you are buying a business. If you do not perform your due diligence correctly, you risk buying a completely unsuitable business for your goals. In addition, not preparing for the due diligence process in advance can slow the sale down and lead to further expense and delay.