05 Oct How to Execute Due Diligence When Buying a Company
There are several paths that lead to entrepreneurship, and one such path is purchasing an existing business. However, before embarking on this path, a thorough examination is necessary to avoid falling into a bad purchase. Knowing where hidden complications may lie can give an entrepreneur the inside track on purchasing a healthy business.
As the potential owner of a business, the early research phase is the time to scrutinize every facet of the company to ensure it is a worthwhile investment. One area that is sometimes overlooked is the legal structure of the business. Its setup should align with the incoming owner’s vision for the business. If it does not, then consult a business attorney to explore alternative solutions, or find a new company to purchase. A properly established business provides the foundation for success. Make sure its structure is setup to meet the plans for projected growth.
The financial history of the business should receive extra attention, as a company’s loans, assets and liabilities will become the new owner’s responsibility. Request all cash flow records, tax returns, vendor contracts and financial ledgers from the last three to five years. (This information should be reviewed with an accountant.) These documents will provide insight on the health of the business’ finances, which will allow the buyer to strategize for the future, review the company’s revenue streams, plan for the terms of future loans and streamline the finances of the company. Any discrepancies in these documents should be studied closely, as past mistakes will haunt the incoming entrepreneur.
Analyzing the long-term components of a business prospect is essential to ensuring it is a healthy investment. Review the company’s internal operations to find any weaknesses in efficiency. Also, look at the relationships the business has with its employees, vendors and customers. If any payments are late or missed, follow the path to uncover why. This can provide clues to the future financial health. Discovering where the issue lies is also important, as it can be a deciding factor in the purchase. Does the issue arise from inefficient internal processes, deteriorated relationships or are the clients struggling financially? The solution can range from an easy fix to an unsolvable, external cash flow issue that will impact the company’s future financial health.
A major piece of the business that will play a large role in the ongoing success of the company, is the staff. Look through employment contracts, employee handbooks and other related documents to understand how the business operates. A transition in ownership can be stressful to the staff, and can erode morale and reduce productivity. Prior to making any decisions, pay attention to the potential issues that could arise from existing employee policies, and talk with current employees. Keeping the staff happy will make the entire process smoother, and it will improve the long-term outlook for the business.
Due diligence is what will determine if a business purchase is successful. Assuming the role of a detective and tracking down suspicious information can uncover potential complications that may change the outcome of the purchase decision. Fully vetting a potential investment is the time to ask questions, address concerns and to learn how the business operates. When purchasing a company, it is recommended to consult a qualified business attorney, as they know the correct questions to ask, and where to uncover red flags.