Due Diligence for Buying a Business
If you are on track to buying a business, be sure to exercise your due diligence as you move forward in the process. Too often does a buyer focus on price of the deal or other factors while neglecting other important aspects of a business purchase. The due diligence phase starts from when you make the first contact with the seller and usually lasts until closing. During this important time frame you are expected to learn as much as you can about the business and identify any issues which may be key for the purchase.
Every business purchase is different and can range from the very simple and straightforward to a very complex multi- party transaction spanning months to complete. As a buyer you will need to gauge the transaction as a whole and perform the right level of due diligence warranted for the transaction. It is imperative that you complete your due diligence before you are legally obligated to any purchase. How you go about the purchase will determine when and what level of legal obligations you may incur from first contact to closing.
The first contact for a business transaction will often result in the drafting and signing of a non-disclosure agreement and a letter of intent. The non-disclosure agreement (NDA) will protect the seller of the business from any confidential information being misused by the potential buyer or their agent. Sometimes it makes sense for the NDA to also protect the buyer of a transaction. There can be many reasons for this, some include security or finance regulations, personal, or general privacy reasons.
Following the NDA and further preliminary discussions, a letter of intent (LOI) will usually follow. While the letter of intent is typically not a binding contract there are some aspects of it that may bind the buyer and seller. These can include: an exclusive timeframe to conduct negotiations, initial deposit requirement, or laying out the basic contingencies such as financing or construction terms. Generally the buyer and seller will lay out the general terms for how the transaction will proceed and any conditions that each party must complete.
After the LOI, the due diligence period begins in earnest. You due diligence period is the time for you to dig deep into the details of the business and transaction and find any important information that may influence your decision or key factors of the transaction. It is typical that any issues discovered by the buyer during the due diligence period will be considered and potentially resolved by the buyer before closing. There are 3 general areas of the due diligence we encourage our clients to explore: financial review, contracts review, and litigation/other review.
Financial Review
Reviewing the finances of a potential business purchase is often one of the first steps. Sometimes the basic financials are used to give a general valuation on the business. You should review the profit/loss statement, balance sheet, and revenue statements to start. Digging deeper you will want to look at the tax statements (for the business but perhaps for the seller if it is a pass through tax entity), company payroll, loan docs, and accounts receivable/payable. Unfortunately, most small businesses do not keep the best records. You will want to have at least one if not a few professionals help you decipher the financials and better study the health of the business. This can include an accountant, CPA, and attorney.
Contract Review
After understanding the financials you should have an idea of the types of ongoing contracts that the business is liable for. You will want to understand what current and future obligations may be part of the purchase and which you may want to end or continue. These contracts can include: vendor contracts, leases, service contracts, and customer contracts.
Litigation/Other Review
Lastly, reviewing other aspects of the business and potential or previous litigation will give you a firm grasp on the business and your obligations as you move forward. At this point you should investigate the standing of the company with your state tax authority and state business authority. You will be able to determine if the business has any delinquent tax obligations and if it remains in good standing with the state to do business. Sometimes these obligations and delinquencies can transfer in a business sale and should be a major concern. Searching in court and county records will help disclose any current or previous litigation that the seller may not have disclosed. It may also be important to search for any UCC or other liens against property of the business, which may impact the ability of the property to be transferred with the business. These can be difficult steps to navigate for buyers without counsel and it is strongly recommended to have a professional assist.
If you are considering buying a business, call Reidel Law Firm to find out how we can help make the transfer seamless and transparent while protecting your interests. Reach us by the email button below or by calling us at +1(832)510-3292.
