Most due diligence to buy a small to mid-sized business takes 7 to 24 days. What is important is that you have all the important information from the business you are buying well before it begins. When making your offer to buy a business make sure you give the list needed for due diligence to the business broker or business owner (or both) who is selling the business.
A due diligence checklist is important when starting your investigation and verifying that special business for sale. Below is a check list of some of the items you and your CPA or consultant will need while completing your investigative due-diligence and verifying items like adjusted net income amounts, etc.
Due Diligence Checklist:
1. 3-5 Years of Past Complete Tax Returns
2. 3-5 Years of Past Complete Financial Statements - Profit & Loss Statements, Balance Sheets
3. Current Interim Financials
4. Current Inventory Report
5. List of Assets Being Sold With The Business
6. Current Accounts Receivable Report
7. Current Accounts Payable Report
8. Checkbook Register for Last 3-5 Years
9. Client List - Look For Account Concentration Issues
10. List Of Employees - Current & Past Payroll Records
11. Schedule Time To Chat With Key Employees & Manager(s)
12. Get A Current Copy of all Licenses Utilized by the Business
13. Current Copy of the Lease
14. Run Lien Report Through Escrow
15. Ask For Any Past Environmental, Appraisal, Legal Reports & Information
16. Have The Seller Complete & Sign A Seller Disclosure Form
17. Get a Current, Complete Vendor List - Review Contracts & Relationships
18 Copy of All Contracts, Leases - Equipment, Advertising, Suppliers, etc.
As a buyer, you need to know that the financial information you are using in your decision-making process to buy a business is reliable. Most buyers think that checking whether information is reliable is the same as checking whether it is accurate.
In fact, accurate financial information is often unreliable. Reliable data is both accurate and representative of the business’ true performance.
The following are examples from due diligence reviews that illustrate this important point:
1. Substantial dead and slow-moving inventory at a Tile & Marble Importer/Distributor that was not disclosed by the seller. Buyer A was presented with a large warehouse with well-organized inventory--all with an indefinite shelf life. Buyer A’s purchase contract included full payment for the entire inventory. Over time, most businesses accumulate inventory that doesn’t sell. Sellers often feel that selling the business is a means of getting rid of accumulated, slow-moving inventory. Buyers shouldn’t have to pay for sellers’ past mistakes. Once uncovered, the purchase price was adjusted downward.
2. Buyer B was enticed by the rapid growth of a construction company doing work primarily for the state of California. It took between 60 and 90 days to collect its receivables from the state. There had been substantial growth in the net income in line with the growth in sales. The purchase price included the value of some of this projected growth. Cash flow forecasts to the buyer showed that a substantial amount of the cash generated by the business would be required to fund the receivables in order to achieve the anticipated level of growth. This meant that, while the net income and tax liability would be high, Buyer B would not be able to withdraw any salary from the business. Buyer B had been concentrating on the net income number without a keen understanding of the business’ cash flow cycle. Buyer B ended up organizing additional financing and incorporating this previously unidentified cost into his analysis and successful offer.
3. A medical supply company received substantial rental income for medical equipment directly from Medicare. The typical rental period lasted 15 months. Both the net income and cash flow had shown tremendous growth. Buyer C failed to recognize that, with rental agreements, the appropriate measure for monthly growth is not revenue, net income, or cash flow. It is the dollar value of new rental originations each month that counts. Here the business was in fact declining while the sales, net income, and cash flow were all growing. In this case, Buyer C chose to look for another business.
4. A specialty chairs company due diligence revealed a surprisingly low delivery expense in comparison to what was commonly observed in the industry. Further investigation revealed that a related company made many of the deliveries without any charge to the business. Buyer D would not have such a relationship and would need to factor in this additional charge in order to sustain the operations of the business. The tax returns had overstated the earnings relative to this expense. Other adjustments were made in the opposite direction. Sorting through the appropriateness of each of the disclosed adjustments and identifying any undisclosed adjustments are critical to a meaningful valuation. The seller agreed to revise the selling price based on the adjustment to normalize the delivery expense.
These examples and countless others demonstrate the importance of a professional due diligence review. Since it is unlikely that you will be presented with audited financial statements in accordance with U.S. Generally Accepted Accounting Principles with footnotes, it is your responsibility to ensure that the data you use is reliable. You do not want to be blindsided by one or more of these and numerous other common and potentially costly errors. These costs can far exceed the relatively small preventive cost of having professional due diligence services performed.
About The Author: Peter Siegel, MBA is the founder and President of BizBen.com - If you are selling a business and need professional assistance utilizing high performance advertising, marketing, and highly effective strategies, or individual customization with your BizBen Power Search options in buying a California business, you can reach him at 925-785-3118.
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