Do you know what you’re buying? Due Diligence when Buying a Small Business
“Due Diligence” is an oft-heard expression in the business for sale industry, but what does it really mean, and why is it so important?
Buying a business can be one of the most liberating and life-changing decisions of your life. If you get it right, you can invest in an opportunity that not only makes your money, but holds its resale value and transforms your lifestyle.
If you don’t ask the right questions and conduct in-depth research to check all the facts, you run the risk of spending your hard earned money on a business that is not worth the price you paid for it, and potentially burning a once-in-a-lifetime investment pot. This is where the Due Diligence process becomes important.
What is Due Diligence?
Put simply, Due Diligence is the act of fact-checking a business opportunity to ensure that the business is all that it claims to be. Whenever someone researches a business they’re thinking of buying, whether that’s by looking at the past 3 years’ accounts, researching a business’ online reputation or simply counting the footfall outside a retail premises, they are conducting due diligence.
Why carry out Due Diligence?
As consumers in the UK, we are used to a certain level of consumer rights. If we buy a new item in a shop and it doesn’t work as promised, we can usually take it back to the retailer for a replacement, repair or refund.
These consumer rights don’t extend to the businesses for sale market, however. If you buy a business and – on inspection – you discover that the business is not all that you were promised, it is much harder to undo the contract and collect a refund. As with all business ventures, there is risk attached to a business purchase. It is the business buyer’s responsibility to ensure that they know precisely what they are buying before they sign contracts and put the money down.
Another important reason for due diligence is that it clears the path of potential problems that could crop up when you take the business over. Self-employment is hard work; the role of an entrepreneur carries more responsibility than that of a traditional employee role, so you need to make the transition into ownership as smooth as possible. It’s vital that you know precisely what you are buying and what you will need to focus on when the deal goes through and you take the reins.
Learn from the experience of others: What buyers wished they had known at the time
We asked the members of UKBusinessForums what they wish they had known when buying a business. The 3 most popular answers were…
- TUPE: make sure that you are fully aware of your responsibilities to your new employees when you buy a business.
- Liabilities: if the business has debts or other major financial commitments, make sure you know what these are beforehand.
- Tax issues: make sure you know what taxes are due over the coming months.
See the original forum post here
What’s a ‘normal amount’ of Due Diligence?
You might feel confident in the person and business you are buying from, but that doesn’t exempt you from due diligence. Due diligence is important even if you have total faith in the good intentions of the seller; issues that the current owner doesn’t consider a problem could be a problem for you, so you need to make your own judgement on every aspect of the business.
You can never do enough due diligence, but at the very least, you want to be able to say to yourself...
- I know what I am buying
- I know the person I am buying from
- I understand the risks and problem areas of the business I am about to buy
- I am confident that I understand what the first 6 – 12 months of my business is going to look like (within reason)
- I know how much the business owes, and what the commitments of the business are, going forward
- My business plan is based on facts about the current business, rather than assumptions about the future business
How to conduct Due Diligence
The nature of your due diligence work will change depending on the type of business you are looking at.
If you are purchasing a small catering van, then you would need to check that the van is roadworthy, that the list of contacts (festival organisers, local councils etc.) is real and up-to-date and that you get sight of any contracts that will continue beyond the business transfer date.
If you plan on buying a high street retailers, in addition to checking the past years’ accounts and footfall, you might also want to consider aspects of the business that will affect its future. For instance, have any staff members handed in their notice? Are any staff due to retire? Are any big supplier contracts due to expire soon? How many years have you got left on the lease? Are there any roadworks or major municipal works due to take place that could affect your business’ ability to earn over the coming months?
If you are spending hundreds of thousands of pounds on an established corporate-level business, then you need to ensure that you are aware of any debts you are taking on, that you understand your commitment to your new employees, and that you understand how long your contracts are. The bigger the investment, the more risk, and the more important it is to conduct thorough and detailed due diligence.
Due Diligence doesn’t insulate you completely from risk, but it does give you a baseline on which you can build your business plan. You should always be on the lookout for potential issues on the horizon, but if you have carried out your due diligence effectively this should leave you in a position where you can be calm and confident that the foundations of a solid business are there, and that your investment is sound.
By Sam Haythornthwaite at DaltonsBusiness.com