Why Due Diligence?
More often than not, when a business is for sale, the buyer and seller will have competing interests. The buyer wants a lower price, and the seller wants a higher price. This alone creates the need to protect a buyer from paying too much.
Unlike the higher level of duty sometimes imposed on a seller in a residential real estate transaction, the rule of law in buying a business is a stark caveat emptor – “let the buyer beware.” You can't expect a seller to tell you everything that's wrong with the business. While no business is perfect, a serious mistake can be financially catastrophic.
Due diligence is a risk management process that can help a buyer determine whether the agreed-upon price is fair. This will require not only a quantitative assessment of the accounting assets and liabilities of the business but also a qualitative assessment of the things that can't currently be measured in financial terms.
A savvy buyer will not be blinded by potential opportunity. Rather, he or she will dispassionately consider, “what could go wrong?”
Some basis questions a buyer will want to consider include –
- Are the accounting numbers reasonable?
- Is the business stable and sustainable?
- Will the revenue stream continue?
- Will the customers stay?
- What's the competitive landscape?
- Will the employees stay? Do you even want them to?
- How important is the current owner to the success of the business?
Beyond the obvious pitfalls of not being able to predict the future, there are other technical concerns. For example, in spite of a buyer's attempts to disclaim all of a seller's liabilities, some may be assumed as a matter of law. That's why it's so important to have the right advisors, including expertise in banking, legal, and accounting/finance.
Once a buyer and seller have reached a written, tentative agreement on price, the due diligence process becomes the contingency that determines whether the purchase is executed. The time allowed for due diligence as well as the nature of the process will be dictated by the value and complexity of the business. For example, the process to purchase a very small business may be limited to as little as 10-15 days. Due diligence to purchase a $20 million business may take months.
Buying and operating a business is not for the faint of heart. There are many things that can go wrong. For this reason, no matter how large or small the business, due diligence is a critical step in the investment process.
Are you considering a business investment? Contact Counterpart CFO for a free, no obligation consultation, and we'll identify specific ways we can help you.