Due Diligence is crucial when buying a business, it’s the most important step of the deal process. Due to its significance, it can be long and intensive with the purchase typically conditional upon this step. It is critical to ensure that Due Diligence is done in a complete and thorough manner. Conducted properly, it should provide the Buyer with a complete understanding of the business they are buying and an analysis of any risks associated with what is being purchased. In short, Due Diligence should confirm or disapprove the rationale for buying the business.
In a typical deal process, there are two parts to Due Diligence. The first is Preliminary Due Diligence which occurs at the start when the Buyer first shows interest and before an offer is made. Once both parties are in agreement and sign a Letter of Intent (LOI), the Buyer then conducts Confirmatory Due Diligence.
Preliminary Due Diligence
Preliminary Due Diligence should occur after the Buyer has determined that the business of interest meets their initial criteria. The preliminary search process takes place in order to provide high-level information on aspects such as:
- Understanding the motive behind the owner’s sell
- Determining the ideal fit based on your goals (Related: Buyer Goals)
- Valuing the price of the company
These questions help determine if the company is worth continuing to the next step: producing an offer.
Confirmatory Due Diligence
Once an Offer Letter is signed, the more detailed and rigorous process of Confirmatory Due Diligence begins. This stage typically has a predetermined, finite timeframe for the Buyer to investigate all aspects of the business. From financial documents to employee benefits, it is important for the Buyer to examine every aspect of the company. This process is essential to ensuring the purchase of the business is, in fact, the right decision and that there won’t be any future buyer’s remorse. Some common types of steps include:
- Financials - Look at the economic situation of the business. There must be consistency among accounts, assets, and liabilities and historical trends, projections, and tax risks.
- Legal - Examine corporate documents, contracts, agreements, and compliance. Ongoing or pending litigation.
- Operational- Review documents related to real estate, operations, insurance, fixed assets
- Human Capital - Assess employee structure, employee benefits, employee contracts, pay structure, etc.
When buying a business, Due Diligence plays a big part. Yet, there are situations where buyers fail to conduct it properly and end up paying the price after the deal has been made. Here are common pitfalls buyers can come across during Due Diligence:
- Insufficient Time - Don’t rush through the process, while it may be tempting, especially when you are excited about the business, ensure that you are giving yourself ample time to go over the information. If not, you may run the risk of uncovering negative surprises later on.
- Excessive Time - While it may be tempting to prolong the process in hopes of getting more information, at some point, you must come to a decision to move forward or walk away from the deal. If the process drags on for too long, the deal loses momentum, which will slow everything down and can even kill the deal.
- Performing Due Diligence Solo - Completely taking on Due Diligence is a lot. Know your limitations and consider hiring an attorney who may have expertise in this arena.
- Conflict of Interest - Don’t rely on someone who has a conflict of interest. It is crucial to take the facts as they are and get a clear, unbiased view on the opportunity- there’s no other way.
- Too Little Information - We all want to avoid the situation of having a concerning liability appear after the deal closes. Make sure you have enough information to prevent any unforeseen risks popping up. Having a Due Diligence Checklist is helpful in ensuring all your bases are covered.
- Non-verifiable Information - Don’t always accept the information provided by the seller at face value. It is important to verify the data you receive and cross-reference it with any and all outside sources.
Mistakes are an important part of life. Yet, conducting Due Diligence is an area where you don’t want to minimize the mistakes made.
Decide if a business is worth buying by conducting Preliminary Due Diligence and then validate your decision by conducting Confirmatory Due Diligence. The process of Due Diligence is the opportunity for you to better understand the business at hand, all while ensuring there are no undiscovered red flags that affect your willingness to complete the transaction. It’s can be a laborious process but the reward of having a solid business, in the end, is certainly worth it.