business_due_diligence

Business due diligence: what is it and why do you need it

So you’ve just been on one end of a business transaction, where the offer has been accepted. Welcome to the world of business due diligence!

What is business due diligence?

Anyone who has bought or sold a business knows that one of the most important parts of the transaction comes after the offer has been accepted. Due diligence refers to the examination of business data to verify the financial and operational standpoint of an enterprise. For the process to be successful, co-operation between the buyer and seller is essential. Effective due diligence means the seller is able to properly exit the business ownership and proceed to the sale. In contrast, unsatisfactory due diligence could lead to the deposit being refunded and a new buyer for the business being sought. Here is what to expect from business due diligence.

Why have a business due diligence checklist?

At the end of the Due Diligence process, you should have a clear picture of where the business is today, where you can take it in the future and why the owner is selling. Buying a business involves careful consideration of many issues and as such should be undertaken in an organised and orderly manner. The purpose of a checklist is to highlight some common areas for a business buyer to consider when buying a business. GMO has two checklists depending on whether you are buying or selling a business. It often helps to work through a due diligence checklist with someone, so you can eliminate or add steps where needed. This could be a broker, accountant, or lawyer.

Conducting relevant services

The review of company contracts is a time-consuming, yet integral part of due diligence. A range of sub-categories falls under the broad umbrella of material contracts.

They can include :

  • Guaranties, loans, and credit agreements
  • Customer and supplier contracts
  • Agreements of partnership or joint venture; limited liability company or operating agreements
  • Contracts involving payments over a material dollar threshold
  • Settlement agreements
  • Past acquisition agreements
  • Equipment Leases
  • Indemnification agreements
  • Employment agreements
  • Exclusivity agreements
  • Agreements imposing any restriction on the right or ability of the company (or a buyer) to compete in any line of business or in any geographic region with any other person
  • Real estate leases/purchase agreements
  • License agreements
  • Powers of attorney
  • Franchise agreements
  • Equity finance agreements
  • Distribution, dealer, sales agency, or advertising agreements
  • Non-competition agreements
  • Union contracts and collective bargaining agreements
  • Contracts the termination of which would result in a material adverse effect on the company
  • Any approvals required of other parties to material contracts due to a change in control or assignment.

As fun as navigating fine print can be, this part is often where solicitors and accountants can come in handy. It never hurts to have a second set of eyes, even if you are experienced in the realm of business transactions.

Financial health of the business

It is natural for a buyer to leave no stone unturned when it comes to the financial side of the business they are purchasing. This means not only gaining an insight into the current financial state of the business but also its economic history. A company’s annual, quarterly, and monthly financial statements for the preceding three years tends to reveal its performance and condition. Other key considerations include whether the financial statements have been audited, the validity of projections for the company, the condition of assets, the appropriateness of the capital and earnings budgets, and whether there is any outstanding indebtedness.

Things to think about for taxation

Tax considerations within business due diligence almost deserve their own list, given their importance and abundance. A buyer must make sure they are familiar with the tax obligations of the entity before taking over as owner. This may involve obtaining confirmation that all tax obligations (for example, income tax, GST, PAYG withholding, stamp duty and payroll tax) are up to date and paid. The review should also include examining all correspondence with the ATO to determine whether any private tax rulings, tax elections, amended notices of assessment, etc may apply to the business, as well as the outcome of any previous or ongoing audits.

Employees

A business is not just financial statements and revenue streams. There are living, breathing parts that can be essential to a smooth transition of ownership. Administrative information such as wages, salary, and superannuation is as important to a buyer as understanding the culture of the workplace they are taking over. Not all change is bad, but news of a business on the market can make its employees feel unsettled. A change in management has the potential to compound any existing staff issues, which is why it helps to know the current environment.

Trading stock

One of the advantages that buying a business carries is the potential to hit the ground running with an established customer/client base. This can only be achieved if the new owner knows the target market. A list of the top customers and the revenue generated from them will contribute to the buyer’s understanding of the diversification within the client base. It is also worth finding out what impact if any, the change in ownership will have on the company’s customer base, as well as how satisfied they are in their current relationship with the company.

Business properties

Assets can be split into two groups – intangible and tangible. Intangible assets include intellectual property, trademarks, operating systems, designs/drawings/logos, recipes, and formulae, whereas tangible assets consist of office, equipment, machinery, computers, and sometimes vehicles. When it comes to the former, a buyer could want to know if the company has taken the appropriate steps to protect its intellectual property, as well as what registered and common law trademarks it has. Tangible assets such as equipment can be assessed in terms of efficiency and whether it is in danger of becoming obsolete. A company could have a list of assets which would definitely be worth a look.

Warning signs for buyers

The very nature of the business due diligence process means there are multiple ways to tell if something doesn’t add up. For the buyer, these red flags usually come in the form of the seller not meeting one or more of the various requirements. If a seller refuses to disclose important information (e.g. their reasons for selling, financial statements, licenses and permits, staff contracts), or if they won’t introduce you to their suppliers, landlord or estate agent, then it might be time to reconsider your options. A seller who is involved in legal proceedings, or has a questionable credit history may also be the wrong person to buy off.

A business due diligence checklist by GMO business brokers

Even if you’re an experienced business buyer it is still a good idea to have an additional opinion to help you reach an informed, well-balanced decision and to ensure a smooth settlement. Through having been in the business sales industry for a long time, we have met and worked with many of Perth’s best advisors. If the business due diligence is not to your satisfaction, or your finance is refused, then your deposit is refunded and GMO will present

you with other businesses to consider. Far more likely: business due diligence, finance and lease issues will all be satisfied and you are now positioned to become the proud owner of the business. Contact us by e-mail or call us at +61 894 81 4422.

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