Due Diligence Questions when buying a Business : Think of buying a company?
If you do your homework, it can be a great idea.
This decision is a complex one which requires a thorough analysis of physical properties, financial statements and the relations between the company and its customers, community and competitors.
Do not try to carry out this analysis on its own to assess and pricing the business, especially when you have not at least three years of experience in owning and managing a similar company.
Due Diligence Questions when buying a Business
One of the last phases of a company is due diligence.
You have made an offer to purchase a business at this point.
You met the owner already, checked the finances and the opportunity looks great.
After negotiations, you two finally agree on an agreement.
However, before it is closed, the deal is subject to certain contingencies.
What is due diligence when a company is purchased?
Due diligence is the correct and accurate verification of the information about the business provided by the seller.
Due diligence is a condition of the buyer’s offer in nearly all sales.
The business terms must meet the buyer’s expectations before the agreement is finally concluded.
If any problems are uncovered, they must be addressed.
Be sure to prepare in advance for this part of the process.
What should be included in a checklist for due diligence?
A checklist of due diligence should cover many aspects of the future business, including financial documents, legal matters, transactions, employee relationships and all assets, products and customer information.
Due diligence is a complex process that should not be carried out without your accountant and lawyer’s assistance.
Consider recruiting professionals to support this process.
The following is a list of documents and information that you should review:
A. Good Standing and Organization
The Articles of Incorporation of the Company, as well as all amendments
The Company’s Bylaws, as well as any amendments to them
The Company’s minute book, which includes all shareholder and director minutes and resolutions, executive committees, and other governing bodies.
The organizational chart of the company
The Company’s shareholder list, including the number of shares held by each.
Agreements pertaining to options, voting trusts, warrants, puts, calls, subscriptions, and convertible securities.
A Certificate of Good Standing from the Secretary of State of the state in which the Company is incorporated.
Copies of the last three years’ active status reports in the state of incorporation
A list of all states in which the Company is authorized to conduct business, as well as annual reports for the previous three years
A list of all states, provinces, and countries in which the Company owns or leases property, employs people, or does business.
A list of all of the Company’s assumed names, as well as copies of their registrations
B. Financial Details
Audited financial statements and Auditor’s Reports for three years.
The most recent unaudited financial statements, with comparisons to the previous year.
Letters and responses from auditors over the last five years
If available, the company’s credit report.
Projections, capital budgets, and strategic plans of any kind.
If available, analyst reports
A list of all debts and contingent liabilities
Inventory schedule Accounts receivable schedule
Accounts payable schedule
A description of depreciation and amortization methods, as well as accounting method changes over the last five years
Any examination of fixed and variable costs
Any gross margin analysis
The general ledger of the company
A description of the internal control procedures used by the company.
C. Material Assets
A list of fixed assets and their locations
All filings with the U.C.C.
All equipment leases
A schedule of major capital equipment sales and purchases over the last three years
D. Property Management
A list of the locations where the Company does business.
All real estate leases, deeds, mortgages, title policies, surveys, zoning approvals, variances, or use permits must be copied.
E. Intellectual Property
A list of patents and patent applications issued in the United States and abroad.
A list of trademarks and trade names
A copyright schedule
A description of critical technical knowledge
A description of the techniques used to safeguard trade secrets and know-how.
Any “work for hire” contracts
A schedule and copies of all consulting agreements, invention agreements, and intellectual property licenses or assignments to or from the Company.
Any patent clearance paperwork
A schedule and summary of any intellectual property claims or threatened claims made by or against the Company.
F. Employees and their Benefits
Employees’ positions, current salaries, salaries and bonuses paid in the previous three years, and years of service are all listed.
All employment, consulting, nondisclosure, nonsolicitation, or noncompetition agreements entered into by the Company and its employees.
Key employees’ resumes
The Company’s personnel handbook, as well as a schedule of all employee benefits and policies regarding holidays, vacation, and sick leave.
Plan summaries for qualified and non-qualified retirement plans
Copies of any collective bargaining agreements.
A description of all employee issues that have occurred in the last three years, including allegations of wrongful termination, harassment, and discrimination.
A description of any labor disputes, arbitration requests, or grievance procedures that are currently pending or have been resolved within the last three years.
A list and description of all employee health and welfare insurance policies or self-funded arrangements, as well as their benefits.
A history of the worker’s compensation claims
A description of the history of unemployment insurance claims
Copies of all stock option and stock purchase plans, as well as a schedule of grants under those plans
G. Permits and Licenses
Copies of any applicable government licenses, permits, or consents.
Any correspondence or documents relating to any regulatory agency’s proceedings.
H. Environmental Concerns
If applicable, environmental audits for each property leased by the Company.
A list of hazardous substances that are used in the Company’s operations.
A description of the disposal methods used by the company
A list of permits and licenses related to the environment
Copies of all correspondence, notices, and files pertaining to the EPA, state, or local regulatory agencies
A list that identifies and describes any environmental lawsuits or investigations.
A list that identifies and describes any known superfund exposure. A list that identifies and describes any contingent environmental liabilities or ongoing indemnification obligations.
Income tax returns for the previous three years (federal, state, local, and foreign)
Sales tax returns from the previous three years
Reports from auditing firms and revenue agencies
Any tax settlement documentation from the previous three years
Employment tax returns for the previous three years
Excise tax returns for the previous three years
Are there any tax liens?
J. Contracts for Materials
A list of all subsidiaries, partnerships, and joint venture relationships and obligations, along with copies of all related agreements.
Copies of all contracts entered into between the Company and any officers, directors, 5% shareholders, or affiliates.
Loan agreements, bank financing arrangements, lines of credit, and promissory notes to which the Company is a party.
Security agreements, mortgages, indentures, collateral pledges, and other similar agreements
All guarantees to which the Company has agreed to be a party
Any agreements for installment sales
Distribution agreements, sales representative agreements, marketing agreements, and supply agreements are all examples of contracts.
Any letters of intent, contracts, and closing transcripts from recent mergers, acquisitions, or divestitures.
Any stock option and stock purchase agreements involving stakes in other companies
Standard quote, purchase order, invoice, and warranty forms used by the company.
All nondisclosure and noncompetition agreements to which the Company is a signatory
Every other material contract
K. Product or Service Lines
A list of all existing products and services, as well as products and services in development.
Copies of all correspondence and reports pertaining to any regulatory approvals or denials of any Company’s products or services.
A list of all complaints and warranty claims.
A summary of all tests, evaluations, studies, surveys, and other data pertaining to existing products or services as well as products or services in development.
L. Client Information
A schedule of the Company’s twelve largest customers in terms of sales to them, as well as a description of those sales over a two-year period.
Any supply or service contracts.
A summary or copy of the Company’s purchasing policies.
A summary or copy of the Company’s credit policy.
A list of orders that have yet to be filled.
A list of any major customers lost in the last two years, along with an explanation.
All surveys and market research reports pertaining to the Company, its products, or services.
Current advertising programs, marketing plans and budgets, and printed marketing materials for the company.
A list of the Company’s main competitors.
A list of all pending lawsuits.
A description of any potential legal action.
Copies of insurance policies that may cover pending or threatened litigation.
Documents pertaining to any injunctions, consent decrees, or settlements to which the Company has agreed.
A list of unsatisfied verdicts.
N. Insurance Protection
A schedule and copies of the Company’s general liability, personal and real property, product liability, errors and omissions, key-man, directors and officers, workers’ compensation, and other insurance policies.
A list of the Company’s insurance claims over the last three years.
A list of all law firms, accounting firms, consulting firms, and other professionals hired by the Company in the previous five years.
P. Publicity and Articles
Copies of all articles and press releases relating to the Company that have been published in the last three years.
What is Due diligence
The purchase of a business is frequently a life-changing event that necessitates a significant financial investment as well as a significant amount of time.
Conducting proper research is critical for obtaining the facts and information needed to make informed decisions and mitigate potential risks and unknowns.
Due diligence is the term used by buyers to describe the investigation and verification of information involved in a potential investment or acquisition.
Due diligence includes doing your “homework,” gathering the necessary legal, financial, and operational documents, and verifying the seller’s representations and material facts pertaining to the business sale.
While most professionals associate the due diligence phase with the execution of a binding agreement with earnest money held in escrow, the process actually begins with the first point of contact with the seller and/or the seller’s intermediary.
Buyers should be prepared to sign a Non-Disclosure Agreement and provide basic personal, financial, and work experience information to the seller before receiving any confidential data about the target.
Most business sellers hire a business intermediary or broker to represent them, and it is the responsibility of the business broker to ensure that the prospective buyer has the financial capability and business experience to be considered viable.
If third-party financing is required, the buyer should consult a lender ahead of time and obtain a pre-qualification letter.
A knowledgeable business intermediary should be able to connect you with a variety of funding sources active in the small business lending arena.
Due diligence is a very detailed process that will provide you with a much clearer and more complete picture of the company you are about to buy, whether or not the asking price is reasonable, and its future earning potential.
You should be able to uncover any problems or issues with the help of an experienced business broker, as well as your attorney and accountant, and make an informed decision about whether or not to purchase the company.
The following are some of the benefits and drawbacks of purchasing an existing business:
• The company already has established relationships with both customers and suppliers.
• Financing will be easier to obtain if the company has a track record of profitability.
• Operations can begin immediately; existing inventory can be sold to generate immediate cash flow.
Because you are frequently purchasing “goodwill,” the cost may be higher than starting from scratch.
Existing issues can be concealed until after the sale.
Inventory may be obsolete due to age, and equipment may be defective.
Steps to Conduct Due Diligence for an Asset Sale:
Step 1: Investigate:
The first step in an evaluation should be a review of the company’s Offering Memorandum, also known as a “Confidential Business Review” (CBR).
While the content of this document will vary depending on the seller, it will frequently include the following:
Detailed description of the company
Organizational Structure (C-Corp, S-Corp, LLC, Partnership, Sole Proprietor)
History & Location
Products and Services Number of Full-Time and Part-Time Employees
Recast (normalized) financial statements for two to three years
Profit and Loss Statement Balance Sheet
Asset List with Fair Market Values
Listing Price & Business Valuation
Preliminary SBA Loan Approval
It is a delicate balance to provide the necessary information to the buyer in order for them to make an accurate evaluation while also protecting the sellers’ need for confidentiality.
In some cases, less information is provided upfront, but this will increase over time as the buyer-seller relationship matures.
A review of the CBR should be sufficient to determine whether this business meets the buyer’s basic criteria based on their goals, skills, and financial resources.
Step 2: Examine:
In the vast majority of cases, the process will end with a review of the CBR.
If the buyer has confirmed an interest in pursuing the opportunity further, the next step is usually a teleconference or email exchange with the business broker.
This communication should serve as a forum for Q&A from the reviewed documents, as well as a more comprehensive and analytical review of the operations, financials, and business valuation.
Following clarification of the points of interest, the buyer should re-evaluate whether this business meets their personal acquisition needs.
The broker or seller will almost certainly assess whether a mutually beneficial situation exists and will almost certainly verify that the buyer is indeed financially qualified for the particular business.
Step 3: Site Inspection:
Prior to touring the business and meeting with the owner, the buyer should have a thorough understanding of the company, its products and services, its organizational structure and staff, its financial performance and profitability, and its valuation.
Most business owners are heavily involved in the day-to-day operations and management of the company, so it is critical not to waste time and energy (for all parties involved) if the aforementioned issues are not thoroughly understood and acceptable prior to scheduling a site visit.
Because the majority of small business sales are ‘confidential,’ the employees are unaware that the company is being marketed for sale, putting greater emphasis on covering as much ground as possible prior to facilitating a company tour.
The site visit and owner meeting provide the buyer with an opportunity to assess the facility and operations firsthand.
Furthermore, this meeting allows both the buyer and seller to determine whether the necessary synergy and chemistry exists for a successful transaction.
Prior to leaving the meeting, the buyer should have a thorough understanding of all aspects of the business, allowing them to provide a Letter of Intent if a decision to proceed is made.
If more information is required prior to the LOI, a data request via email or a brief teleconference can easily be arranged to obtain any missing details.
Step 4: Write a Letter of Intent:
A Letter of Intent (LOI) is typically prepared once the buyer determines that they have a serious interest in purchasing the company.
An LOI is a written document that expresses the buyers’ serious desire to enter into a formal contract and further the discovery process.
At its most basic, the LOI states that if certain criteria specified in the LOI are met, the buyer will purchase the company and the seller will sell the company in accordance with the terms outlined in the LOI.
An LOI is also known as a Memorandum of Understanding (MOU) or Term Sheet, though the style of these documents varies greatly.
The letter of intent (LOI) is a simple document that defines the basic terms and conditions of the proposed acquisition, such as the type of acquisition (stock or asset), purchase price, financing method, contingencies, data required to complete due diligence, and timelines for the Definitive Purchase Agreement submittal and closing.
LOIs are typically not legally binding unless so captioned; however, most will contain legally binding provisions, such as non-disclosure agreements and no-shop (aka stand-still) provisions.
A no-shop clause will frequently result in the seller requesting an earnest money deposit as compensation for the time the business was off the market in the event that the buyer fails to close.
LOIs benefit both the buyer and the seller.
The primary goal of the LOI is to confirm that both parties have reached a “meeting of the minds” prior to both parties making the large investments of time, energy, and expense required to execute a Definitive Purchase Agreement (DPA), also known as an Asset Purchase Agreement (APA).
It is important to note that in some cases, a buyer will have obtained and examined enough company records, financial statements, and tax returns to feel comfortable foregoing the LOI and presenting the DPA instead.
Step 5: Extensive Due Diligence:
Due diligence continues after a LOI is signed.
The goal of due diligence is to give the buyer the opportunity to verify the owner’s representations made during the selling process.
When the financials, tax returns, and company documents (lease, permits, licenses, employee manuals, etc.) are clean, well organized, and professionally packaged, the process typically takes 2-6 weeks and can often be completed with relative ease.
Larger business transactions involving multiple locations, intellectual property, and complicated products will take longer.
It is critical for the buyer to understand that some highly confidential information, such as customer databases and contracts, may not be made available until a binding DPA is executed and the contingencies are removed.
A competent business broker, in collaboration with a CPA and an attorney with business transaction experience, will add enormous value to the DD process.
Buyers who use third-party financing will benefit from the involvement of a loan packager because they will conduct their own independent due diligence, acting as an additional set of eyes for the buyer.
If it hasn’t already been done, the buyer should be ready to provide the seller with a loan proposal or commitment letter.
Creating a realistic timeline ahead of time will ensure that each party is aware of what documents are needed and when they should be produced, avoiding unnecessary frustration and delays.
Focus areas for business acquisition due diligence:
Accounts for Revenue, Cost of Goods Sold, and Adjusted Earnings Assets and Liabilities
Inventory Receivables and Payables Furniture, Fixtures, and Equipment
Capital Expenditures on Real Estate/Lease
Business Entity Tax Filings (Sole Proprietor, LLC, C-Corp, S-Corp)
Lawsuits Intellectual Property Contracts for the Environment (Employee, Customer, & Vendor)
Goods and Services
Customers and Suppliers
Infrastructure & Personnel Technology
Markets and Competitors
Agreement on Non-Competition
During the due diligence process, buyers may notice discrepancies in data from previously received information.
In most cases, these issues can be resolved successfully through open communication between both parties.
The nature of the inconsistency and the financial impact the discrepancy has on the transaction will determine whether any points of the transaction documents must be renegotiated.
Step 6: Execution of the Definitive Purchase Agreement (DPA):
The DPA is a legally binding contract between a seller and a buyer of a business or business assets.
This document establishes the terms and conditions of the transaction and will include contract provisions that discuss the cost of purchasing the business, the contingencies involved, and the legal structure of the transaction.
The DPA is typically drafted following the acceptance of the LOI.
The DPA is a much more comprehensive document than the LOI and will include a variety of representations and warranties (legal assurance that certain facts are true) from the seller about the company’s operations and assets, as well as conditions and indemnity provisions.
The DPA will also include covenants, which are promises made by the buyer to the seller and promises made by the seller to the buyer to do or not do something.
Furthermore, it will describe in detail which assets are included in the sale or specifically excluded from the sale, free and clear of all third-party claims (unless expressly stated and agreed upon).
This includes inventory, real estate, vehicles, FF&E, contracts, customer lists, and anything else the company possesses at any given time.
Finally, the DPA will include a number of boilerplate provisions as well as the closing conditions.
The due diligence process continues after the DPA is submitted.
Several steps that are commonly taken following the DPA include:
Lawsuit & Lien
Title Search for Real Estate and Vehicles
Examining leases (assignability)
Inventory valuation (typically completed the day before closing) *
Analysis of accounts receivable and payable
Application/approval of a dealership or franchise
Contract review for employees, customers, and vendors
* A lender may refuse to allow last-minute changes to inventory.
As a result, the buyer and seller should have a written agreement outlining how inventory adjustments will be handled.
Activities for Transition:
It is recommended that the buyer develop a personal transition plan for the business during the due diligence period to ensure that they are adequately prepared once the closing occurs.
Establishing the following are some of the more critical items recommended for the transition plan:
Certificate of Legal Entity / DBA / Assumed Name Business Checking Account Business Insurance Licenses / Permits
Schedule for owner training/consulting
Revise/create a business plan
Financial analysis on a pro forma basis
Step 7: Finishing:
Closing procedures will differ depending on local custom and the protocol of the individual attorneys.
The transaction closing is the time when all parties sign the necessary documents, usually at the buyer’s attorney’s office, and is recognized as the date when the buyer becomes the new owner of the business.
A final ‘walk through’ can be performed immediately prior to closing, depending on the buyer’s last visit to the business.
If no unforeseen issues arise on the day of closing, the buyer/seller contingencies are satisfied, the buyer’s funds are deposited in the attorney’s escrow account, and both parties are prepared to sign a significant number of documents, the buyer’s funds will be released to the seller, and the buyer receives legal title and the keys to the business’s assets.
What are the key questions for business due diligence?
A strong understanding of the target company is essential, therefore, corporate structure due diligence questions and business due diligence questions include: Current by-laws of the company Ownership information Overview of the structure of the company (diagrams and charts are valuable here) List of security holders Communication with stockholders List of outsourced work – freelancers, consultants, etc.
What are the key questions to ask?
With this in mind, product M&A questions to ask include: With this in mind, ask about: All services and products Production costs Production margins Past and predicted growth rates
What information should I collect during due diligence?
Specifically, collecting financial statements from the last three to five years; tax related due diligence questions are especially important.
What information should I ask for?
Also, you will want to ask for: Tax returns (usually the last three years) Credit reports Reports demonstrating the value of all products Dissection of gross profit margins Dissection of expenses (both fixed and variable).
What is Due Diligence?
Due diligence is defined as the research and analysis of a company or organization done in preparation for a business transaction (such as a corporate merger or purchase of securities).
What is the cap?
In fact, major companies such as some of the Big Four (PWC, EY, KPMG, and Deloitte) put a cap on the number of consecutive diligence projects employees can work on ( learn about Due Diligence Process in Mergers and Acquisitions (M&A)).
What are the benefits of using check-lists and playbooks?
While we believe practitioners should be wary of blindly following due diligence checklists since practitioners must first focus on their own companies’ strategies, goals, and values, there are basic due diligence questions for acquisitions that M&A practitioners can start with; these checklists and templates can help with initial due diligence and give less experienced acquirers a sense of standard due diligence questions when buying a business.
What are the key customer relationships?
Knowing all of the customers, and honing in on the most substantial customers in terms of sales, is key.
What are the legal ramifications?
Customer information also becomes highly legal, as all contact and correspondence with customer’s attorney should be disclosed, as well as any litigation.
What Is Due Diligence?
Due diligence is the process of verifying the information about the business, as provided by the seller, is correct and accurate.
What should I include in a due diligence checklist?
A due diligence checklist should cover several aspects of the prospective business, including financial documents, legal issues, operations, employee relations, as well as all assets, products and customer data.
What Is Due Diligence?
One of the final phases of buying a business is due diligence.
What financials should I include?
This includes audited financial statements over the last three years.
What are the financial details?
Financials: Income statements, cash flow statements, balance sheets, general ledger, accounts payable and receivable Credit report Tax returns for at least the past three years All debts, their terms and any contingent liabilities Analysis of gross profit margins Analysis of fixed and variable expenses Gross profits and rate of return by each product Inventory of all products, equipment and real estate, including total value
What are the key factors affecting your business?
This is your opportunity to review and verify the business model, customer base, products and services, as well as labor, materials and operational costs.
What are the legal issues?
Any patent clearance documents A schedule and summary of any claims or threatened claims by or against the Company regarding intellectual property
What are the key information sets that you need to know?
Articles of Incorporation and all amendments The Company’s Bylaws and all amendments The Company’s minute book, including all minutes and resolutions of shareholders and directors, executive committees, and other governing groups.
Where do you operate?
A Certificate of Good Standing from the Secretary of State of the state where the Company is incorporated Copies of active status reports in the state of incorporation for the last three years A list of all states, provinces, or countries where the Company owns or leases property, maintains employees or conducts business.
What are the financial and operational information you have available?
financial statements for three years, together with Auditor’s Reports.
What are the key financial and accounting issues?
Analyst reports, if available A schedule of all indebtedness and contingent liabilities A schedule of inventory A description of depreciation and amortization methods and changes in accounting methods over the past five years Any analysis of fixed and variable expenses Any analysis of gross margins The Company’s general ledger A description of the Company’s internal control procedures
What are the legal issues surrounding a business acquisition?
Regardless of whether the deal is structured as an asset transaction, a stock transaction, or a merger , make sure you know what you are getting into by requiring detailed information from the seller regarding its business operations and finances.
What are the requirements for a U.C. C. filing?
A schedule of fixed assets and the locations thereof All U.C.C.
What are your goals?
Or, do you want to acquire another small business to expand your existing one?
What are the benefits of due diligence?
If you answered yes to any of these questions, you need to know about due diligence and how it can inform your purchasing decision.
What is Business Due Diligence?
When you do due diligence, you will look at several aspects of the prospective business or product.
What Is Due Diligence?
Due diligence is an investigation into the business or product you are interested in buying.
What are the risks?
When conducting due diligence, you will look at key issues of the business or product, including profits, financial risks, legal issues, and potential deal breakers.
What is business due diligence?
It involves digging through a business’s records , checking references, making sure everything checks out, and searching for items the business might have hidden.
What Are The Best Business Due Diligence Services?
Hire an accountant and a lawyer who have experience in this area.
What do I need to sign?
When you start the business due diligence process, you will sign a confidentiality agreement with the other business owner.
What is a due diligence checklist?
Next, go through a due diligence checklist with your accountant and lawyer to make sure you hit all parts of the due diligence process.
What is financial due diligence?
Financial due diligence, also called accounting due diligence, looks at the economic situation of the business.
What are the key financial information?
Look at past annual and quarterly financial information, including: Balance sheets Cash flow statements Look up the rates of return by product.
What are the key factors?
You’ll also look at historical trends, projections, and tax risks.
- Fairly safe investments will return 5% annually.
- Copies of all contracts between the Company and any officers, directors, 5-percent shareholders or affiliates. (westmoreland.score.org)
- * Copies of all contracts between the Company and any officers, directors, 5-percent shareholders or affiliates. (reuters.com)
- Copies of all contracts between the Company and any officers, directors, 5-percent shareholders or affiliates. (findlaw.com)
- Copies of contracts between the company and directors, officers, affiliates, and minimum 5 percent shareholders.
- The Best Lawyers For Less Hire the top business lawyers and save up to 60% on legal fees (upcounsel.com)
- With this in mind, product M&A questions to ask include: With this in mind, ask about: All services and products Production costs Production margins Past and predicted growth rates 4.
- With this in mind, product M&A questions to ask include: With this in mind, ask about: All services and products Production costs Production margins Past and predicted growth rates 4.
- With this in mind, product M&A questions to ask include: With this in mind, ask about: All services and products Production costs Production margins Past and predicted growth rates 4. (dealroom.net)