So you’re looking to buy a business, and you think you’ve found one that might suit. What’s next?
Even experienced business owners will espouse the values of having a Due Diligence done on the prospective business, to ensure the business will give the returns you need, and ensure you pay a fair price for the going concern.
Let’s start with the basics…..what IS a due diligence?
The misconception is that a Due Diligence is simply checking the historical performance of the business. In reality it is much more. The past performance certainly provides good data, but it’s the current and future options you’re looking to capitalise on, so a good Due Diligence needs to go much broader.
In simple terms, the Due Diligence process needs to cover the past, present, and the future of the business.
Apart from just the financial aspects – the following should be looked at:
- Staff – how many staff does the business employ and in what capacity, are there employment contracts in place, are there restraint of trade provisions in the contract, are there provisions relating to employee retention, termination or compensation in the event of a change of ownership of the business? Are there any outstanding employee disputes or a high staff turnover in the last 3 years?
- Intellectual Property – is there any documented IP or copyright or trademarks associated with the business. Is the true intellectual property all in the “current owners’ head”?
- Marketing Collateral and reputation – does the business have a market presence online? What’s its reputation like? Is its online presence up to scratch or in need of a revamp and investment. Do the website and social media sites form part of the contract of sale, and does the owner have permissions and capability to transfer ownership?
- Market penetration - looking at the competitors to the business can give you an indication of market share and potential growth. It can also lead you to the reasons the business might be for sale i.e. a new competitor has entered the market at cheaper prices and the business is losing market share. Can you turn the business around, are there new product lines you can introduce, are you able to shave your margins, or should you walk away?
- Equipment – look at the age and maintenance on equipment. Are there any big ticket items you will need to replace in the near future? Are these leased or owned outright, do they form part of the sale contract? Check the asset register which should form part of the sale contract very carefully, and a physical inspection of the business will point out anomalies.
- Ensuring stock is at a good trading level, and checking the amount of redundant stock will give you a truer indication of the actual sales turnover. Some businesses will look more profitable because the current owner has run down stock levels over a period of time, which means you’re in for a hefty figure to restock once you take over. Businesses who don’t have good stock rotation practices will leave the new owner with high quantities of expiring or redundant stock which needs to be discounted or disposed of. You need to ensure any expiring or redundant stock is not included in the stock valuation at settlement.
- Insurance - Start with the simple question – Can you get insurance – some industries are very specialised and getting an appropriate level of cover at the right price may not be achievable.
And my personal favourite…..are you the right person to be the owner of that business?
This can be the trickiest of all the parts of a due diligence especially if you already have an emotional connection to the business.
On more than one occasion over the last 12 months potential buyers have decided against a business not because the business wasn’t good, but their personality and lifestyle just didn’t match the requirements of the business.
Things to consider:
- What personality type are you and does your management style suit the business?
- How are you at dealing with difficult conversations/conflicts?
- How many hours do you want to spend working?
- What are the hours of trade and any restrictions?
- Do you like dealing with customers directly?
- Do you like control or how much control do you need to have?
- Is the industry heavily legislated?
Whilst the above questions don’t have anything to do with figures, they’re necessary to determine if the business and you are a “good fit”.
A thorough due diligence will ensure the financial and human investment in your new business venture will be well spent. By taking the emotion out of the purchase and having a professional due diligence undertaken will give you a thorough investigation into the important aspects of the business, and give you negotiating power to (in many instances) lower the asking price. It may also give you the information you need to walk away and find a more suitable business for your needs.
If you’re considering buying a business and want to go in with your eyes open, reach out to a PJT Advisor for a confidential first discussion about what we can include in a due diligence.
Keep an eye out for next month’s article: Due Diligence and Digging through the Figures.