Buying a Small Business? Do Your Due Diligence

One of the upside’s of a down economy is the opportunity to purchase a small business at a reduced rate. However, resist the temptation to get blindsided by the low cost. Whether you are considering the acquisition of a corner pizza parlor or a multi-national corporation, conducting a due diligence examination is extremely important. Closely scrutinize the business plan, internal documents, corporate filings, taxes, licenses and all legal documents. The process should also involve the services of lawyers, accountants, appraisers and industry consultants.

Assess the Products, Marketing and Competition

Examine the product you are buying and where it stands, competitively. Is it established and have a loyal customer base? Determine whether it will provide an opportunity for growth that is in line with your current business model and how the product or service stacks up against competitors. These are extremely important due diligence considerations. Carefully review the business plan to see what the current owners have encountered and what they recommend as the marketing “fix.” Combine their insights with your own strategic plan, understanding the costs and risks involved to make the business competitive and sustainable.

Explore a business plan assessment of sales and revenue projections for 3-5 years; competitive analysis; marketing and advertising costs; research and development costs; new product development or line extension opportunities; feasibility to expand, sell or discontinue products to reduce costs; production and distribution cost reduction opportunities, partnership and joint venture opportunities.

Look Closely at the Legal Status and Liabilities

Check corporate documents with an eye towards any legal issues that you might inherit. Investigate public records over the last five years for past or impending litigation against the company and current owners. Review contracts with suppliers and outside contractors. Make sure that insurance coverage is up-to-date. Examine employee contracts and agreements and all issues regarding the rights, responsibilities and liabilities of the board of directors.

Pay close attention to confidentiality, conflict of interest and any invention rights and assignment clauses. Hold a meeting with your attorney for an opinion about the company’s legal status. Request full disclosure of all “red flag” issues and identification of areas that require legal corrective action.

Areas of focus should include fulfillment of federal, local and state filing requirements; compliance with codes and ordinances; contracts and agreements; insurance policies; payment status of worker’s compensation; past, pending or threatened litigation; consumer complaints; internal and public legal documents and records.

Check the Current Financial Status

Checking the financial health of the business lies at the “heart” of the due diligence process. Examine and determine if the company is stable and ready to become the next “it” corporation or is on “financial life support”. Remove all emotion during this phase. Get a clear and honest picture of the financial condition to assist in setting your acquisition price.

Focus on the business plan, budget projections, taxes for the last five years, bank account statements and things such as loans, notes, and letter of credit agreements; mortgages and leases; internal financial reports (monthly, quarterly, annual report); physical assets and real property, including real estate, inventory, machinery and equipment; with an eye towards valuation, depreciation, longevity and replacement costs. Get professional appraisals.

Review the Existing Corporate Structure

This is a broad area that should absolutely involve assessment and review with lawyers, accountants and those familiar with the operational aspects of the industry. Closely examine documents for clauses that relate to acquisition, first right of refusal, stock transfers and any area that might impose a condition or restriction.

Examine the organizational structure. Assess the strengths and weaknesses of the current management team, existing employees, and departments in terms of continuation, replacement, or termination.

Areas of focus should include the Articles of Incorporation, By-laws, licenses, stock ownership and records, board of directors meeting minutes as well as filings and registrations with state, local and federal agencies.

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