The due diligence process entails performing an investigation into the enterprise that you are thinking of purchasing. In other words, you will need to become an expert so that you avoid harming your financial health and wellbeing.
In some cases, you may wish to buy out one of your competitors, or the business proposition may be quite enticing. However, you will still need to create a due diligence checklist before buying the business, and we will delve into the reasons why below.
Benefits of Buying an Existing Business
There are four main types of business organizations: Sole proprietorship, partnership, corporation, and Limited Liability Company, or LLC. The advantages of buying an existing business are that you will have immediate access to an existing clientele. You will also have a faster time to market and will be able to rely on the existing knowledge and expertise of your current staff.
You will also be able to take advantage of a direct position in the market and will have convenient access to licenses and certificates on-demand. What’s more, you will only have to deal with limited risks, as the existing business has already absorbed most of the risk factors for you, and you will also only have to deal with limited research on formalities; such as local governance, legal requirements and systems, and tax procedures and systems.
How to Conduct Due Diligence
In order to conduct proper due diligence, you should work closely with an accountant and a lawyer so that you will be protected financially and legally throughout the process. During your investigation of your new business, you will need to carefully review all of the necessary income statements, as well as the profit and loss records over the last two or three years.
In addition, you should also go over the records of accounts receivable and payable, as well as utility accounts, and payment and cash deposit records. You should also request privacy details, which may involve details on customers, trading partners, and staff, as well as review lines — or letters — of credit, bank loans, and tax returns and balance sheets for the last three to five years of business activity.
In addition, you should never simply take the seller’s claims about the enterprise as being factual, and should instead look into their reason for selling, as well as assess the reputation of the company in question.
What Should I Have in My Due Diligence Checklist?
The most important things to have in your checklist are information on assets, finances, legal issues, employee relations, and business operations. You will also need to acquire certain business licenses and permits from the necessary agencies, and you will also need to renew them periodically, usually every two to three years, depending on which province you live in.
A Certificate of Good Standing
A certificate of good standing will also be needed. A certificate of good standing basically demonstrates that an enterprise has complied with all regulations in the business’s province of origin and that it has filed all of the necessary paperwork and paid all of its taxes.
Organizational paperwork is yet another component that you should include in your due diligence checklist. For example, if you wanted to establish an LLC then you would need to file several articles of organization with your province and also pay the required filing fees. The organizational paperwork would also include pertinent details about your business, such as its registered agent, as well as its address and name.
Environmental regulations are yet another factor to consider. That is, you may need to get in contact with the EPA, or may need to legally register your new business with the Environmental Protection Agency to avoid lawsuits and sanctions. You may also need to meet certain small business goals, and look into various socioeconomic programs, and explore the EPAs procurement forecast.
A Letter of Intent
A business acquisition letter of intent will also be required, which will declare in writing that the parties involved are currently negotiating definitive agreements and are in the process of exploring third-party approvals and finalizing the due diligence process.
A letter of intent can also be seen as a contingency plan for a possible worst-case scenario, such as the complete and utter collapse of the deal during the negotiation phase.
Legal, Operational, and Financial Due Diligence
Finally, you will need to consider the human capital, operational, legal, and financial aspects of due diligence. In other words, you will need to verify equipment, buildings, and furniture, as well as balance sheets, sales records, tax returns, cash flow statements, debt disclosures, the status of inventory, accounts payables and receivables, and advertising costs.
Consequences of Not Doing Due Diligence
If you plan to merge with another company or wish to acquire a new business, then comprehensive and thorough due diligence are a must. Otherwise, serious consequences may arise that may not only impact the viability of the transaction but also directly impact the profit forecasts. Due diligence is needed to accurately gauge profits and future associated forecasts, as well as to consider the proposed business plan of the company in question.
In the event that a dispute does arise during negotiations then your legal arguments will be strengthened via your due diligence of the seller’s operations. Failure to perform due diligence can also lead to fraud fiascos in the future.
Due diligence can be used to uncover fraud that has been committed by either the customers, the staff, or the vendor themselves. You will also be able to expose the operational weaknesses of the company that may go unnoticed without the proper due diligence.
For example, you may discover during your investigation of the company that its employee turnover rate far exceeds the number reported by the vendor.
Moreover, failure to perform the necessary due diligence may lead to compliance issues in the future. Due diligence is needed to determine the degree of compliance, in regards to adherence to any and all applicable laws and regulations. It can also be used to determine what steps need to be taken in order to bring the enterprise back into a compliant state.