August 5th, 2009 by Bruce

So, what exactly is due diligence and why is it absolutely essential when purchasing a business?

Due diligence is definitely the most important aspect of any buying transaction. It is the period when you will have complete access to all company files and records as a final step to analyze the business and uncover any potential problems.

While the legal due diligence period usually starts after an agreement is made with the seller, to stay clear any pitfalls a buyer’s methodical investigation of the business should start the instant a business becomes of personal interest. And so, due diligence is an all-encompassing part of the buy a business process.

The due diligence process goes beyond a simple review of financial statements and tax returns. In actual fact, due diligence when buying a business involves every detail associated with the business in question.

The due diligence checklist starts with the information accumulation stage. This will enable you to establish a pros and cons list about the business. During this due diligence process, think of yourself as a detective trying to uncover everything you can about the business. Before approaching the seller, do a bit of basic information researching utilizing the Internet. As an aspect of your due diligence checklist, look through online records to find out whatever you can about the business you’re currently interested in purchasing. Also do online research into the industry sector, suppliers, competition and the overall market outlook.

Based on the information gathered, formulate questions that need to be asked of the seller. If you are pleased with what the information is revealing about the business, it’s time to move on to the next phase of the due diligence process and contact the seller.

Due diligence when purchasing a business is incredibly important when making any sort of offer before the actual acquisition. At this point, due diligence is crucial when going over all of the business records. As part of the due diligence process, create a list for the seller of all the materials you want to review. Then, establish a timeline for yourself with respect to what you intend to investigate, how much time you’re dedicating to each part of the business, and which parts you’ll need professional advice, for example, a CPA or business lawyer.

While many sellers or brokers like to rush the inspection phase of the due diligence process, allow yourself the time you need. A minimum of a 20 business day time period is an acceptable amount of time for the inspection stage in most contracts, but if you need longer, don’t be afraid to ask for it. And remember, the formal due diligence process that is referenced in any business purchase agreement should not begin until you have all the materials requested from the seller.

Take your time when reviewing all the business operations books, financial statements and tax records. Always keep your due diligence checklist on you so that you can write down questions, follow-ups and other points you want to go over with the seller. As part of the due diligence when buying a business, it’s common to find inconsistencies or questionable items. Write them all down on your due diligence checklist and set up a meeting the seller when you’ve finalized your due diligence process. The information will assist you with building a case for discerning whether renegotiation of price, terms or deal parameters may be required.

If your due diligence uncovers some major problems and the seller declines to renegotiate the deal or fails to accept your solution, then you must have the right to walk away as long as the agreement has language that allows you to do so. Therefore, make certain any agreement you sign protects you during the due diligence period when buying a business or else you may have a major problem. In fact, business industry statistics show that 5 out of 10 deals fall apart in the formal due diligence process stage.

If after completing your due diligence checklist you are not 100% certain about buying the business, then you might need to investigate further or walk away from the deal. Consider what about the business is giving you an uncertain feeling. Perhaps you need to gather additional information. Or maybe your due diligence revealed areas of concern that make you feel uneasy. Or it could just be cold feet. If additional due diligence will not ease your concerns, then it’s best to walk away.

Due diligence when buying a business is all you have to go on in order to make an informed decision on whether or not to purchase the business. When conducted properly, your final decision should be an easy one.

Richard Parker is the author of the How to Buy a Good Business at a Great Price series. As President and founder of Diomo Corporation – The Business Buyer Resource Center, his materials, seminars and consulting have helped thousands of business buyers realize their dream of buying a business.

Business, Business operations, Business process, Company, Small Business