Understanding Due Diligence in Business Transactions
“Due Diligence” is crucial for both buyers and sellers in business transactions. It involves thoroughly researching every aspect of the business, including financials, reputation, and growth potential.
As a prospective buyer, be aware that the seller will conduct Due Diligence on your financials and reputation as well. Preparing your financial documents is essential to showcase your ability to run the business effectively.
Advantages of Purchasing an Existing Business
Buying an established business comes with numerous benefits, including:
- A recognized brand name.
- An existing customer base with proven market demand.
- Resolving zoning and permitting issues beforehand.
- Improved access to financing due to a established track record.
Six Essential Steps in Buying a Business
Start by identifying your reasons for buying a business and the type that fits your lifestyle.
1. Define the Business Type You Want
Consider your passions and skills—are you drawn to agriculture, entertainment, manufacturing, or another sector? Decide if you prefer ownership as a sole proprietor or managing a larger operation, such as a franchise.
2. Start Your Business Search
Consider engaging a business broker who specializes in the type of business you’re interested in or conduct your own searches in your desired geographical area.
3. Evaluate Business Options Carefully
Understanding why a business is being sold can indicate its viability. Reasons may include retirement, health issues, or seeking new challenges.
4. Utilize a Comprehensive Buying Checklist
As you navigate the buying checklist, be cautious of red flags such as declining financial health or overwhelming owner exhaustion.
5. Secure Financial Capital Beyond Just Purchase Price
Explore financing options, including seller financing, banks, or Small Business Administration loans. This can be an advantageous route due to the existing business’s proven profitability.
6. Finalize the Purchase with Legal Protection
Ensure all documents are reviewed by a legal professional before signing to protect your investment.
Key Considerations Before Committing to a Purchase
Investigate Local Business Conditions
Assess whether the industry is thriving in the area and examine any pending development that could impact operations.
Review Inventory and Supply Agreements
Check the status of inventory and any contracts tied to it, such as supply agreements, which can significantly affect cash flow.
Conduct Equipment and Intellectual Property Assessments
Verify the value of tangible assets and ensure that vital intellectual properties, such as trademarks, are included in the sale.
Follow a Rigorous Due Diligence Process
Go through financial statements, contracts, and perform a historical review to ensure nothing is overlooked.
Understand Employee Structure and Policies
Examine current employee agreements and the organizational structure to ensure smooth operations post-purchase.
Create a Business Plan Post-Purchase
After acquisition, develop a business plan that aligns with both the current operations and your future goals.
Timeline for Purchasing a Business
The process can take between 8 to 12 months, and it’s advisable to seek regular updates during this time.
Essential Documents to Request
When considering a business purchase, be sure to ask for:
- Profit and loss statements from the last three years.
- Tax returns over the past three years.
- Leases and current balance sheets.
- Copies of insurance policies and any existing agreements.
Key Questions to Ask
Ask yourself what motivates you to buy and inquire of the seller their reasons for selling, along with their availability for consultation during the transition.
