Due diligence is probably the most critical stage in the buying process. Many prospective buyers incorrectly identify this period as strictly a financial review. However, an effective due diligence goes far beyond the numbers. Due diligence is the complete investigation and review of a business.
One of the keys to buying a good business comes from your ability to learn the intimate details of it. To identify the strengths, weaknesses, pluses, minuses, growth opportunities and areas of concerns. If you don’t do a flawless job of gathering information, you will not be able to pull the trigger and complete the transaction since you’ll be uncertain about too many components of the business.
The investigation process must begin the moment a business becomes of interest. Your goal is to be certain that you uncover everything about any business BEFORE you buy it. You don’t have to meet the seller or even visit the business for your research to begin. The Internet is an incredible tool that will allow you to investigate the business, the industry, the competition, the marketing, the suppliers, etc.
The importance of beginning your investigation early on cannot be emphasized strongly enough. This way, you’ll position yourself to ask the seller the right questions. Once you progress to the stage of an accepted offer, you will commence the inspection or financial due diligence. This period usually lasts 10-30 days. This is the time when you’ll have access to all of the company’s books and records.
Once you begin looking at a particular business, you’ll find a thousand things crossing your mind regarding the acquisition. Keep a notepad handy at all times and log your to do’s. You’ll have many thoughts about things “I need to check out”. Write these all in one place. Don’t trust your memory; these little things are the ones that can and will come back to haunt you down the road. Begin to put together your checklist of what you need to investigate and how you’re going to do it along with the materials you require from the seller to accomplish it.
A couple of things to keep in mind:
Prepare properly:
Since you’ll have some time restrictions (you’ll only have x number of days per the contract), provide the seller with a listing of all of the materials required for you and/or your accountant to complete this exercise. No matter what you’re told, do not begin the process until they have everything ready for you.
Allow yourself enough time:
Many sellers and some business brokers will press for a very short inspection period; sometimes just days. Don’t get bullied into this – give yourself ample time to complete this part of the process.
What about surprises:
You’ll probably find some surprises, don’t panic, it’s normal. Work through them. Get clarification. Build your case. Don’t run to the seller or broker every time you find an inconsistency between what you’ve seen versus what you were told. No business is perfect. The rule to follow is do not treat any incidents as catastrophes nor should you treat any catastrophes as incidents. If you find a major problem, get your facts in order and you can then decide the appropriate action to be taken with the seller (i.e. renegotiation, walking from the deal, etc..)
According to industry statistics, nine out of ten people who begin the search to buy a business never complete a transaction. While there are many reasons for this dismal figure, a lot has to do with the inability of people to “pull the trigger”. This gun-shy reaction is due to uncertainty: if you have not gathered the right information or failed to investigate the business thoroughly you will not be 100% certain of what to do. And so, you’ll drop the project. Conversely, if you do a flawless job of investigating the business, and everything else adds up right, then making the final decision is simply one more step in the process!