5 Ways to Exercise Due Diligence When Buying a Businesses

Posted on: 31 July 2015

When buying an existing business, typically more research is required than some of the checks and balances than you would undertake before buying a home or car. Its no doubt daunting, but to ensure the living, breathing business that you are considering purchasing is exactly how it has been represented, its essential that all buyers – or someone on their behalf – undertake investigations to verify the health of the business. Based on these checks, known as 'due diligence', the buyer can reduce the risk involved in buying.  Based on what the investigations find, the buyer has three options: asking for certain conditions to be met before buying, walking away from the sale, or negotiating a better price. Depending on the size and complexity of the businesses, the level of investigation and assessment required for the below factors will vary.

Checking the Business's Financial Health

Don't take the owner's information about the business's cash flow at their word—financial health checks are arguably the most important areas buyers should investigate. As well as checking tax records, financial statements, and profit and loss statements for at least the last three years, prospective buyers should see if bills are being paid on time, and how much money is owed to the business, as this is debt that the new owners will be inheriting.

Be sure profit statements are real rather than projected profits, and verify that profit takes into account things like owner's wages and depreciation expenses for business assets. When it comes to financial records and paperwork, all sellers should provide this information cooperatively, otherwise it can be a warning sign to walk away.  Buyers may wish to undertake the services of an accountant or business broker in order to assess these financial records thoroughly.

Lease Details

Some businesses may have insecure leases, a lease that is about to expire, or a demolition clause that could jeopardise the future operation of the business. To have peace of mind about future security and operation of the business at the same location, leases should be clear and transparent, with ideally at least 2 years before the lease is due for renewal. Commercial real estate agents, like those at PRDnationwide, may be able to help offer further information on working with lease agreements.

Assessing Staff and Employee Entitlements

Outstanding entitlements to staff or the number of staff on the books should be assessed before purchase, as existing staff will often be inherited with the business. Be wary of businesses that depend on one key person with certain skills, knowledge or relationships with clients, as this can increase risk should that person leave the business.

Condition of Business Assets

All prospective business owners should assess key pieces of equipment that are essential to the smooth operation of the business. For example, if the business is a restaurant or café, and refrigeration or commercial kitchen equipment is nearing the end of its useful life, this may be able to be negotiated for replacement before purchase. At the very least, always ensure all equipment is operational before settlement.

Assess the Business Landscape

Finally, one of the most important areas to assess before buying a business is the projected future success of that business. Be careful of buying a business based on future potential rather than the existing growth or strengths the business has previously undergone. Where possible find out why the owners are selling and speak to customers, suppliers and clients about the business and any problems they may have experienced. Assess any threats that may impact the business in the future. For example a newsagency owner may want to sell because of the downturn in print media, so its important to consider any impact that could affect future profits. Remember: the less risk, the higher price you'll pay, with more risk translating into a lower asking price.

Buying a business means assessing the sum of all its parts. A commercial real estate agent or business broker will be able to assist navigating the sale of a business including assistance undertaking these key areas of due diligence. Performing these checks shouldn't necessarily scare you away from a sale, but it's important to understand the financial health of the business fully before considering your offer.