What to Check Before Purchasing a Business

Due diligence is one of the last steps in buying a business. For example, you have made an offer to buy a business. After meeting with the owner, you have reviewed the financials and decided that the opportunity is perfect. After much negotiation, you both finally reach an agreement on a deal. However, before the deal can be finalized, there are certain conditions.

What does due diligence mean when purchasing a business?

Due diligence refers to the verification of the accuracy and truthfulness of the seller's information. In almost all cases, due diligence is a condition of the buyer's offer. Before the deal can be finalized, the business conditions must meet buyer expectations. If any issues are discovered, they should be addressed immediately. Prepare for this step of the process in advance.

What should a due diligence checklist include?

Due diligence should include all aspects of the potential business, including legal issues, financial documents, operations, employee relationships, and all assets, products, and customer data. Your attorney and accountant can help you with due diligence. This is where professionals can help.

1. Verify all financial information

These include audited financial statements for the past three years. Remember that small business financials are usually compiled by the seller to minimize taxes. Therefore, they will need to explain every detail, including the owner's benefit (SDE) and cash flow. To review, verify, and possibly recast all numbers, your accountant should meet the seller's accountant. These are the documents that you will want to look at:

• Financials: Income statements and cash flow statements, balances, general ledger, accounts receivable, and balance sheets.

• Credit report

• Returns of tax for the last three years

• All debts, terms, and contingent liabilities

• Analysis of gross profit margins

• Analyze of fixed and variable costs

• Rate of return and gross profits for each product

• Inventory of all goods, equipment, and real estate, including total value

2. Verify the business structure and operation

Examine the structure of the company and how it makes its profits. Information about the market, trends, and competitors could help determine the company's future earnings potential. You have the opportunity to examine and verify the company's business model, customer base, and products, as well as labor and material costs. Take a look at:

• Articles of incorporation and amendments to the Company's Statutes

• Amendments to the bylaws of the company

• Summary of current shareholders and investors

• All trademark and company names

• All states in which the company can do business

• All products and services, including production costs and margins

• Compliance requirements for businesses

• Marketing plan, competitor analysis, market trends, and competitors

• The brand identity of a company, including logo, website, and domain

3. All contracts should be reviewed and verified

Are there any joint ventures or partnerships between the company and other companies? Are there any loan agreements, lines of credit for the business, equipment leases, or other indentures? Next, you should find out which obligations and agreements you are required to follow or comply with as part of your business.

• All nondisclosure and non-compete agreements.

• Purchase orders, quotes, and invoices for companies

• Mortgages, security agreements, and collateral pledges

• Letters of intent, contracts, and closing transcripts for mergers and acquisitions

• Distribution agreements, sales, and subscription agreements

• All loan agreements, material leases, and lines of credit, as well as promissory notes

• Contracts between officers, directors, and principals of the company

• Stock purchase agreements and other options

4. All customer information should be reviewed and verified

Check all customer databases and lists. Determine who the biggest customers are in terms of sales and what they have purchased over the past 2-3 years. What are the ways these customers were acquired and kept? Are they on renewal subscription agreements? Take a look at:

• All customer databases, subscriber lists, and sales records

• Copies of correspondence and standard communications

• All advertising programs, marketing programs and events

• Refund policies and purchasing policies

• Any customer research data, whitepapers, or research

• All lawyers and law firms representing the company in their area of practice.

• In progress litigation or threats to litigation

• Unsatisfied judgments

• All policies and insurance coverage

• All professional licenses, permits

5. Verify all information about employees

Ask for the employee roster and organizational chart of your company. Ask for the names and responsibilities of key employees. This could be a good opportunity to determine if employees are planning to leave the company following its sale and if they would like to stay. Review:

• The organizational chart and employee roster

• Independent contractor and employee contracts

• Information about payroll and forms for employees tax

• Policies and procedures for human resources

• Insurance, retirement plans, and employee benefits

6. You should check for legal issues

For example, who represents the company's interests? Does proper insurance cover the company? Are all necessary permits and licenses valid for the company?

7. Verify all real and physical property

A complete inventory of the company's assets and current market value, including automobiles, real estate, and equipment, is available.

• Real estate includes office locations, warehouses, and current leases.

• A list of all fixed assets, including product inventory, furniture, and fixtures.

• All automobiles and boats

8. Verify all intellectual property

This includes trademarks and copyrights and patents and other exclusive intellectual information owned by the company. Verify:

• All copyrights, trademarks, and patents of the company

• Inventions, formulas, and recipes for product inventions or technical know-how

• All digital data and rights-owned data

• All work-for-hire or consulting agreements

Due diligence is a detailed process that gives you a better understanding of the company you're about to buy, its fairness, and future earning potential. With the help of a business broker and your accountant, you should be able to identify any potential problems and make an informed decision about whether to buy the company.