Due Diligence

Due diligence is one of the most important steps in buying a business. Large enterprises have large teams of people that go into a business being purchased and investigate every facet of how that business has been operating, and whether or not the seller properly represented what they were selling.

The same concept holds true for a small business purchase, except you, as the buyer, may be the only person performing due diligence on your purchase. For an example, let's say you are buying a small plastics manufacturing business that does both custom and proprietary injection molding.

Here are the major areas of investigation you need to perform:

Accounting
If possible, it is always money well spent to have an accountant review the business' bookkeeping process and records. Does their financial reporting properly reflect the actual operation of the business? Are all monies properly accounted for? And so on.

Far too many new buyers of existing businesses have been shocked after they closed the deal and discovered that the business really did not produce the kind of revenue and profit claimed by the seller. Worse yet, is the realization after the fact that the seller has been skirting the law (or outright flaunting it) in order to make their business look good. The time to do due diligence on financial and accounting matters is before you close the deal—not after.

Site Inspection
If you are buying the business because this is your dream—your passion—as well as your area of expertise, then this function of due diligence should be a slam-dunk for you.

The things to look for in a site inspection would be:

Cleanliness and order. I learned at a very young age—and it was reinforced through the years—that a clean and orderly place of business is a highly productive and efficient operation. More importantly—there are no exceptions….it doesn't matter if it is a steel foundry or a bakery…you can tell the mood and content of the employees and how efficient the business is by simply walking through it.

Equipment. It is the most basic function of due diligence to inspect the equipment you are buying. Is it up-to-date technology—or will you need to replace or upgrade it in the near future? Is it in good repair with no deferred maintenance? Is it the right equipment for the right job? Is the equipment installed to allow good workflow? Every business is different, so you should prepare your physical due diligence checklist before you start your detailed inspection.

Building. Whether you are buying the building with the business, or leasing it from someone else, you need to make sure it is in good repair and that you will not have to make repairs or leasehold improvements immediately. You should also determine if the building is suitable for your future vision of how you want to run the business, or will you be looking to move to a new facility in the near future. The fewer major expenses you face when taking over a new business, the better off you will be. Facilities should be a major section on your due diligence checklist.

Employees.
This aspect of taking over a business can sometimes be a problem, especially if the seller had few rules or expectations of the workforce. You should interview a few of the employees at random to determine exactly what you might be facing when you take over the business. Having a revolt of employees on your hands will not make the transition of ownership very pleasant. Better to find out in due diligence than after you have closed on the deal.

Customers.
Contacting and interviewing a sampling of customers would be a good idea so you can get a good idea of what customers think of the business and the people they are normally in contact with. This is usually done in due diligence, because normally the seller would not want either their employees or their customers contacted prior to reaching an agreement in principle.

Vendors.
Certain key vendors should also be contacted to determine how business was conducted in the past and if there were any problems that need to be addressed. This too would be done after an agreement in principle was in place.

Government.
Be sure to check out any license or permit requirements from the government. There should at least be a valid business license, and documentation on any corporations, and payments of fees. These are often overlooked, and can cause problems down the line.

The point of all this due diligence is to do two things; (1) determine if there is anything major that would cause you to want to change the terms of your deal, or that would stop you from completing the purchase; and (2) determine what you will need to do starting the first day you take over. It is not pleasant to close on a sale and then walk into a business that is full of surprises…they are almost always of the unpleasant variety.

If you are buying the business for an investment, and not to run yourself, you may need to bring someone in who has the necessary knowledge of that business to help you with investigation. For a small business this usually does not take very long, and should not cost much money…but it could be the best money you ever spent.

Well, with due diligence behind you, all you have to do is run your new business successfully, and make it grow according to your plans for it. If you need help along the way, you can check out some of the sections and reports on this website that are in place for all businesses. You can find these in the Site Directory (on the NavBar).

If you are still in the process of trying to buy a business, you might take a look at the next report on Buying a Franchise Business. You can also find some additional comments in my report titled, Tips on Buying a Business.

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