Due Diligence and Buying a Business
Is buying a business harder than selling a business? The answer is simple. If you are the buyer then buying a business is harder. If you are the seller then selling a business is harder. If you are a lender then you will say approving a loan is harder. If you are a business broker like me, the answer is that the process is difficult for all parties as the deal will only get done if there is a willing buyer and a willing seller that are under no pressure to do a deal and both parties are fully informed about all the facts in the purchase.
Perhaps the greater truth in all this is that each party considers their side of the deal the most difficult and that’s because they see things from their perspective.
Due diligence and buying a business
Seeing things from each person’s perspective especially comes into play during the due diligence phase. It would be normal that the seller and buyer are very uncomfortable with each other because they have been negotiating head to head to try and get the best deal possible. Now that the negotiations are complete, the transaction moves into the due diligence phase where the buyer is able to verify the representations of the seller and the seller is equally curious to know the buyer can follow through on their representations, for example, getting third party finance approved, being approved by the landlord, being able to qualify if the business or practice has government mandated licenses and more.
As a general rule, however, the purpose of due diligence is to protect the buyer and make sure the acquisition they are making allows what they want to do which is purchase the business from the seller and continue to earn the profit the seller is saying they make and more importantly, better the profit the seller is making.
If you are the buyer of a business, here’s 6 things to watch from your perspective as you move through the due diligence process.
1. Understand what is in the Purchase Agreement or Letter of Intent
The Purchase Agreement or Letter of Intent should detail what will happen during the due diligence period. Some Purchase Agreements or Letters of Intent do not break it down very well so make sure it’s crystal clear.
It’s normal for the seller to agree to open due diligence if the buyer pays a nonrefundable deposit. The buyer does not want to lose any money in case they discover items in due diligence and they no longer wish to make the purchase. Therefore make sure it’s clear; if deposits are paid are they refundable and if so under what conditions? As a business broker I always put the buyers check into escrow as if there is a dispute, the escrow company has a legal process to follow before they can refund or pay out any money.
2. Does the Purchase Agreement or Letter of Intent reflect what you want?
It may sound simple and very basic, but does the Purchase Agreement or Letter of Intent reflect what you want? As the buyer gets deeper into the transaction they get more and more information. Sometimes there is too much information. Regardless, it’s the buyer’s responsibility to ensure they are clear on all the details, especially those in writing as this is their security if something should go wrong or there is a misunderstanding.
To make sure everything is crystal clear, before signing the purchase agreement or letter of intent and starting due diligence, make sure these documents reflect what you need. Even go a step further by creating a checklist of items to accomplish during due diligence and include how long you expect each item to take, a priority of importance and if the item is contingent about something else happening or not happening.
If it helps, get the help of a professional whose job it is to look after your interests and/or explain things to you.
3. What is a reasonable amount of time for due diligence?
The seller generally wants due diligence to be as short a period of time as possible. The buyer generally wants it to take as long as they need as they don’t want to feel rushed and therefore make any mistakes and they want to make sure they get answers to each and every question. This is where I see a lot of sellers make mistakes as they are sometimes reluctant to share too much information in case the buyer backs out of the deal. The seller’s hesitation is reasonable and the goal should be to share what is not commercially sensitive information such as the name and contacts of customers until the transaction closes escrow.
There is no magic or ‘normal’ period of time for due diligence. It varies with each transaction and the reason it varies is that each transaction is unique. The more complex the transaction the longer period for due diligence.
If you are looking for a range of time it should take to complete due diligence then 14 to 21 days would be reasonable. A big caveat here is due diligence can get done much quicker if the seller is organized and has the documents ready for the buyer to inspect. That is, the buyer can normally only move as fast as the seller presents the documents the buyer needs which should clearly be detailed in the Purchase Agreement or Letter of Intent. As a business broker, I try to have as many documents organized as possible so the buyer can start their due diligence. While the buyer is working through the initial set of documents, the seller can work on any additional documents and keep the due diligence process moving forward.
4. How do you manage due diligence?
What is important is that the buyer can feel comfortable working through the due diligence process by removing each contingency in writing as it is satisfied. That is, the buyer can show good faith to the seller by signing a document agreement as each contingency is met and the buyer is satisfied.
Just like the negotiations were difficult so too is the due diligence. If the buyer and seller have been able to get to this stage in the transaction they need to continue working together. The best way to do this is each party to demonstrate goodwill and be patient with each other. I always recommend to the seller to see things from the buyers perspective and similarly I recommend to the buyer, to put their feet in the shoes of the seller.
5. Patience is a virtue
We’ve all heard the expression that patience is a virtue. This is critical during the escrow process. If the buyer feels their questions are unreasonable, the seller is slow to respond with answers or documents they need then the buyer can simply walk. Equally, sellers become frustrated especially if the buyer is slow to ask for information and appears to be dragging things out. Both buyer and seller are unsettled by this major change happening in their lives, that is, the seller is letting go of the business but it’s also been part and parcel of their lives. The buyer is dealing with the emotions of taking a major risk and having to deal with what we all hate in life, that is, the possibility of having to deal with failure.
6. Get the help of a professional(s)
There are many items to address during due diligence. Most are simple and straightforward under normal circumstances. A buyer conducting due diligence on one of the most important decisions they will make in their life is not a normal circumstance. Getting help from the right professional is simply good business.
As the business broker in the transaction, my role is to protect both buyer and seller and I do this by making sure all requests are clearly communicated to both parties, its agreed what needs to be done and how quickly it will be done. If the buyer requires advice on a tax matter I refer them to a CPA or tax professional so they get the right answer. If the buyer requires legal advice, I refer them to a business transaction attorney. That is, I refer them to the right attorney. There are many areas of law and they are each complicated. Because I am a member of the Sacramento County Bar Association I’m able to meet with attorneys with different areas of expertise and this allows me to find the right attorney for the right need.
7. It doesn’t need to be complicated
For the person buying their first or second business it can be complicated. However, this is mainly because there are many emotions at different levels. These include the concern about losing money, making a mistake, getting something wrong or perhaps the deepest emotion of all, trusting that the person you are dealing with is honest.
From my perspective, there is nothing better than owning and operating my own business. It provides the opportunity to reflect my personality and who I am, be responsible for my own success (or failure which I will then learn from,) learn new and exciting skills as the economy changes and adapts and so much more. Due diligence is a critical time for the business buyer to make sure the business meets their needs, gets them to where they want to be and sets them up for success in the future.
If you would like more information about buying a business please visit my webpage Buy a business or buy a copy of my book Successfully buy your business. If you would like more immediate help with buying a business you are welcome to send an email to Andrew Rogerson or give me a call on 916 570-2674.