When purchasing an established business, it is important to evaluate “all of the things” that pertain to the business. This includes not only the financial details of the business to determine both the valuation and what your return on investment might be, but what risks may be associated with purchasing the business. You may also need to look at key staff members, contracts, and referral sources, among other things. So, what is this process called? Due Diligence. Essentially, think of due diligence as everything you will consider prior to signing a binding contract to purchase a business.
What Does Due Diligence Mean?
Due diligence is the process of inspecting and verifying the details of a business before proceeding with the formal legal purchase. Your goal in conducting due diligence should not be “paralysis by analysis”, but, rather, to confirm that the information provided by a seller about their business is factual. Meaning, you can review documentations that support the representations being made about the business. As a buyer, conducting due diligence not only allows you to verify the actual value of the business you are purchasing but also helps you identify any potential risks that you might inherit once the transfer of ownership is complete.
If you are in the process of buying an existing business, performing due diligence will help you uncover any problems that the business might have and plan accordingly. Depending on the severity of the issue at hand, you can either request a structural change to the deal, such as a purchase price reduction or other seller concession, to walk away from the deal altogether (for insurmountable issues), or plan to take corrective action once the transaction is finalized (easily addressed fixes). In short: due diligence empowers you to make an informed decision when buying a business.
What To Expect During the Due Diligence Process
The process of due diligence can be quite complex since it involves auditing various facets of a business and its operations. As such it is advisable to enlist a professional attorney or accountant to guide you through the process to ensure no stone is left unturned. With that being said, here are a couple of things that you should expect when conducting due diligence.1. Assessment and Verification of Financial Records
Your first stop when conducting due diligence should be reviewing and verifying the financial information of the business. This is often referred to as Quality of Earnings (QofE), which can be performed by a qualified accounting firm or other business advisory that specializes in buy-side QofE. As a general rule of thumb, you should only proceed with the process of due diligence if the numbers stated by the seller add up.
Some of the documents that you should request from your seller include:
- Statement of Cash Flows
- Profit and Loss Statements for the last three (3) years and current YTD P&L
- Balance Sheets for the last three (3) years and current BS
- Financial projections, if available
- Tax returns, as amended, for the last three (3) years
- Key business contracts, such as premise lease
2. Review of the Business’ Structure
Make sure your seller provides you with information about the business’ market penetration, competitors, and trends that might help you determine the business’ potential earrings in the future. You should also assess the company’s customer base, business model, and operational costs.
Here are some of the documents your seller should provide you with for business evaluation:
- The company’s Articles of Incorporation and Amendments
- The company’s Bylaws and Amendments
- List of current shareholders and investors
- List of all states, countries, and provinces where the company owns property or conducts business
- The company’s organizational chart
3. Verification of Employee Information
The seller should provide you with information about their workforce and how it is structured. This includes:
- List of all employees, their positions, and salaries
- Resumes of all key employees
- Employment contracts, if applicable
- The company’s personnel handbook along with a schedule of employees' holidays, benefits, and vacation policies
- Copies of collective bargaining agreements where available
4. Evaluation of Physical Assets and Real Estate
You should request your seller to make an inventory of all the assets and property owned by the business. These items should include:
- A list of all furniture, fixtures, and equipment
- Any real estate holdings
- Leasehold improvements
- Lease agreements
While due diligence is critical when buying an existing company, the process can be rigorous and time-consuming. Fortunately, Private Practice Transitions is here to guide you through every step to ensure you make a worthwhile acquisition. Contact us today to learn more about the services we offer.