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Why due diligence matters when buying a business

By Raymond Blin

There could be several reasons why a buyer wants a particular business – location, industry position or existing client book. However, regardless of why you buy the company, you need to undertake proper due diligence to ensure it’s the right move. This process is the most integral part of your search for a business and should be done in advance – and definitely, before any exchange of contracts takes place.

Due diligence is an audit of a business to establish its assets and liabilities. It also serves to evaluate the commercial potential. It is a vital part of buying any company, as it gives you thorough insight into financial records, legal issues and market positioning. It also looks at historical records and projections, helping you understand the risks you may be undertaking after the purchase.

This guide explains why due diligence matters in more detail – and how to conduct it effectively.

Understanding the business for sale

The main aim of the due diligence process is to enable a buyer to understand better the business they’re purchasing and ensure the price they pay reflects the value to be recouped.

By carrying out your due diligence early, you can use it to determine if you are getting a good deal in the purchase and negotiate the price to reflect any risks or liabilities you will be undertaking. In this sense, due diligence is an essential bargaining tool during the sale process.

If your due diligence uncovers potential causes for concern, you may use it to structure a deal that gives you confidence and protection. This can include deferred payments, warranties and indemnities from the seller, which essentially provides the buyer with a right to claim back a portion of the purchase price if any issues arise.

Types of due diligence

A seller should do three predominant types of due diligence when acquiring a business. You might need different advisors for each – depending on the type of business you are buying – so you can ensure the deal is watertight and fair.

  1. Legal – as part of a sales contract, you need lawyers to check that the business has legal title to sell, that they have ownership of all the assets and that any regulatory or litigation issues are fully addressed. If these aren’t reviewed, it could invalidate any deal.
  2. Financial – involves checking the numbers and ensuring hidden economic issues. This is essential to prevent you from buying a business that ends up being a financial strain.
  3. Commercial  – finding out the business’s place in the marketplace and checking competitors and the regulatory environment. It should allow you to uncover the company’s potential performance if you make the right changes – and how much profit you can expect.

Checklist

We’ve put together a checklist of what a buyer should aim to cover in their due diligence process:  

  • Corporate information, including company structure and any subsidiaries, shareholders, option holders and directors
  • Business and assets – such as the business plan, assets, equipment, material contracts with customers or suppliers
  • Human resources, such as employees, employment contracts, directors’ contracts, salaries and wages information, ongoing disputes, pensions data
  • Property – the properties owned, leased or occupied by the business
  • Information Technology and Intellectual Property – software and equipment used, any maintenance and support contracts, intellectual property (IP) used or owned, including all license agreements for domain names, website design, trademarks, and copyrights
  • Data protection, including details of how data is stored, safeguarded and used, privacy policies and GDPR practices
  • Litigation and regulatory – any disputes the company is involved in or likely to begin before purchase, and any licenses or regulatory consents
  • Any relevant health and safety policies or incident logs
  • Insurance information, such as claims history, insurance policies and premiums
  • Financial – including insight into accounts, assessment of tax liabilities, loans, charges and borrowing and VAT records

Once you have completed your due diligence, take time to reflect on the findings and let them lead your purchase decision. If it doesn’t seem worthwhile, it likely indicates you aren’t serious about investing in the firm or that it isn’t the right fit. Aim to make a decision one way or another –  many people find themselves stuck in an endless cycle of due diligence, afraid to make a final decision.

If you fail to undertake the appropriate level of due diligence, it could come back to bite you later, especially if financial shortfalls arise that lessen the value of the business. By uncovering risks in advance, you can ensure you are making the correct decision to buy a company – at an appropriate level and with complete understanding during the negotiation stage.

For assistance in undertaking due diligence of a potential business purchase or any other support to ensure a successful sale, get in touch with a UKBA advisor who can provide valuable expertise.

Raymond Blin | UK Business Advisors (ukba.co.uk)

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