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Conducting due diligence
When buying an established business it is vital that you, the prospective business owner, examine the business in detail. This process is known as due diligence. Due diligence is generally conducted after the buyer and seller have agreed in principle to a deal, but before a binding contract is signed.
Conducting due diligence is the best way for you to assess the value of a business and the risks associated with buying it. Due diligence gives you access to important and confidential information about a business, often within a time period specified in a letter of intent.
With this information you can assess the business's financial position and identify risks and ongoing potential. It is your chance to answer any questions you might have about the business. The due diligence process ensures that you get good value for a business. Done correctly, it can be the difference between buying a business that makes you money and buying a business that costs you money.
You should always perform due diligence with the help of your lawyer, accountant or business adviser.
Investigating a business
To conduct due diligence you'll need to carefully review:
- income statements
- records of accounts receivable and payable
- balance sheets and tax returns including business activity statements (last 3-5 years)
- profit and loss records (last 2-3 years)
- cash deposit and payment records, as reconciled with the accounts
- utility accounts
- bank loans and lines or letters of credit
- minutes of directors' meetings/management meetings
- audit work paper files (if available)
- the seller's claims about their business (e.g. their reasons for selling, the business's reputation)
- privacy details (e.g. of employees, trading partners, customers)
- details about plant, equipment, fixtures, vehicles (are they in good working order and licensed?)
- intellectual assets of the business (e.g. intellectual property, trademarks, patents)
- existing contracts with clients/staff
- partnership agreements
- lease arrangements
- details of the business's automated financial systems
- details of credit and historical searches related to the business.
You also need to value the business to check whether the asking price is fair.
Warning signs for the buyer
You should be wary of sellers who:
- do not disclose important information (e.g. their reasons for selling, financial statements, licences and permits, staff contracts)
- won't agree to a trial period or enough time to conduct due diligence (you will need at least 30 days)
- won't introduce you to their suppliers, landlord or estate agent
- are involved in legal proceedings
- are keen to close the deal quickly
- have a questionable credit record and history.