Conducting due diligence: A complete guide when buying a small business

Buying a small business could provide a lot of benefits to the buyer. You could manage it for life and grow it to be a very successful brand, or you could increase the value and sell it at a higher price later. But you can only get these benefits if you buy the right business. To know whether a business is worth buying or not, you need to conduct due diligence before signing the deal.

Due diligence involves fact-checking a business and investigating if it is what the business or the owner claims it to be. It involves examining the business records, checking the online reputation of the company, interviewing the employees, ascertaining the customer and supplier base etc. Due diligence is no doubt a critical step to be taken by any business or individual prior to making the commitment to any legally binding contract and if done right, should bring peace of mind to both buyers and sellers alike.

Why you should carry out due diligence?

Purchasing a business is almost always a risk that can’t be undone. If you buy a business and you discover that the business is not as profitable as the past owner claimed it was, there is little to nothing that you can do to get a refund. So, it is your responsibility to understand every facet of the business before you purchase it.

When you conduct due diligence, you reduce the risk of losing your money, and you get more information that will help you run the business better. With due diligence, you will also know what to expect, and you can prepare better. You can see all possible problems and issues that may arise, and you can rapidly develop solutions to them.

In a small business scenario, the owner is responsible for overseeing almost every aspect of the business. You need to learn the ropes completely and ensure that everything is as promised. Due diligence will give you in-depth knowledge of how the business is run.

Some of the vital things to find out when conducting due diligence

Most buyers focus more on profitability and ignore some other things that also vital at this stage. Due diligence involves finding out several things, some of which are highlighted below.

• Are there complete employee files including salary, pension and benefits? What are immediate responsibilities to employees? Remember, the impact of employees is more felt in the operations of a small business than a large business. These employees helped the previous owner to run the business, and you need their expertise to help you run the business now, especially if you have little or no expertise in the industry
• Are there any hidden liabilities? You need to be informed of all liabilities no matter how trivial they may be. All debts and financial commitments must be found out.
• What about the tax records, is the business up to date on its taxes? You need to know of any tax issue that the business has and the taxes that are due in the time coming.
• Does the business have a healthy cash flow and are profits going up or down?
• Can you tell where the revenue stream is coming from by looking at the business financial records? How reliable are its financial projections and what multiple is it placing on those earnings?
• How big is the target market for the company’s products or services? What is the market bigger picture? Is the market growing, shrinking or saturated?
• What kind of online presence does the business have, and how does it compare to its competitors?
• Are tangible and the intangible assets been valued correctly and fairly by professionals?
• What about the company documents (Articles of incorporation, minutes of board meetings, tax registration, etc.) are they complete?
• For lease property, when does current lease end?
• What insurance information is provided and what is included in the covered?

What amount of due diligence is needed?

So, some may ask, how do I know that my due diligence is adequate? When do I feel confident enough to say I have done enough due diligence? Well, there is nothing like enough due diligence. Due diligence is not a thing that can be completed. But if you are sure of the following things, you can say that you have a good understanding of the business.

• You know the person or organization that you are buying the business from
• You know, all financial commitments of the business, and you know about all debts that the business owes
• You understand the risks associated with the business
• You know the problems that the business is facing
• You have a robust business plan based on facts that you have obtained about the business. Your business plan is not based on mere fantasies or assumptions
• You have a good understanding of the business outlook within the first one year.
• You know, what are the initial operations requirements to keep the business going in the short-time

Remember, legal counsel should be involved in conducting acquisition due diligence. Over the years, a few strong-headed buyers have been insisting on handling all the acquisition due diligence themselves, or with the wrong advisors, sometimes at their own peril.

How to conduct due diligence?

There is no single method that fits all business. Each business has its unique ways of handling due diligence.

For example, if you are buying a small family-owned restaurant, you need to ensure that all their licenses are valid. You need to know if they are licensed to sell alcohol or not. You don’t want to run into legal problems. You need to know where they buy foodstuffs and the meal order most by customers. You also need to know about customers with special bookings amongst other things.

If you are buying a farm, you need to know when tractors and other farm machinery were purchased and when they are due for servicing. You need in-depth knowledge on the stores that you supply, where you buy fertilizer, how often fertilizer and pesticides are attached, the time for hiring extra farm hands, special tricks for making produce stay fresh etc.

Due diligence when buying online businesses and websites

Due diligence isn’t only for offline businesses. You can also carry out due diligence for online business for sale. You can visit sites like whois.com to determine when the domain name of the business was registered and the person that registered the domain. You also need to understand other analytics like daily traffic, location of visitors, monthly organic site visitors, domain authority, spam scores, SEO visibility etc. Analytics websites like Alexa, Semrush, Moz among others can help you with that.

Conclusion

Due diligence doesn’t entirely mitigate all the possible risks that a business might face. But it goes a long way in cushioning possible risks. It also gives you a solid framework from which you can create your business plan and implement your ideas. Due diligence will leave you better prepared for problems that may pop up later. With due diligence, you can be confident that you made the right investment.

By Philip Harry   |   23/05/2018