You’ve found a business you like and you’re ready to take the next step – but before you start handing anyone your hard-earned money you want a good look behind the scenes and a thorough look at the books. It’s time for due diligence.
What is due diligence?
For business buyers, due diligence is the step that allows them full access to a business – the financial records, contracts, leases, etc. This period of a business transaction is typically after a letter of intent (LOI) is submitted or after an initial offer is accepted. The length of the due diligence phase is something that can be negotiated, but is typically no longer than a few weeks. In that time frame both you and your advisors (like your business transaction CPA, business transaction attorney and your business broker) will be able to go over the business with a fine-toothed comb and see what you are actually buying.
What should I be looking for in due diligence?
This will very much depend on the individual business you are considering as well as the industry the business is a part of, but for the most part you will be looking for any potential issues or problems that the sellers weren’t forthcoming about. Some examples might include unpaid tax debts, more “handshake agreements” than actual written contracts you can count on, pending legal issues and the like. Use the experience of your advisors to determine if anything you find is a deal killer or simply something that warrants a renegotiation with the seller.
What if I find a “deal killer”?
If you find something during due diligence that makes you completely unwilling to go through with the sale, then you will absolutely have a chance to back out of the deal. Keep in mind that businesses are inherently complex, and there is not a business anywhere that is completely devoid of any issues. Your threshold for issues will depend on what you are comfortable with, what can be negotiated and whether or not the funds are available to fix the problem.
What if I didn’t find anything wrong, but something is making me uncomfortable with proceeding?
Gut feelings about a business deal can both help and hurt your chances of getting a deal done. If you are feeling uneasy even after a thorough due diligence, now is the time to seek the advice of your business broker. Did they get the same uneasy feeling about the deal? Are you just apprehensive about making such a huge financial investment, or do you really have something to be worried about? Separating the reality from your own cold feet can be difficult to do, so asking your intermediary can be very helpful in this situation. A good broker won’t steer you wrong, as it is in their best interest for you to be happy and comfortable with the business you ultimately buy. You will need to sell again one day, and your referrals of other business owners you meet are your broker’s bread and butter.
I know we agreed on an offer, but after due diligence I’ve changed my mind. What now?
If something you found in due diligence warrants a renegotiation of price, then your advisory team will help you decide what the new offer might look like. You should be prepared for at least a bit of back-and-forth, as most sellers will probably be unhappy when you decide to offer less money. Make sure your justification for the new price is backed up by whatever you found during due diligence and the renegotiation shouldn’t kill the deal. If you’ve completely changed your mind and now you definitely don’t want the business, you have the opportunity to walk away.
Are you a business buyer with more questions about the due diligence process? Have you been through this process before and have an experience you’d like to share? Please feel free to leave any comments or questions, we would be happy to help.