“Due Diligence” applies to both buyers and sellers of a business.
Due Diligence means you are diligently researching every aspect of the business. Aside from the financials, you’re looking into the business reputation and its potential.
When you are ready to buy a business, you should know that the seller is doing Due Diligence on you! The seller will want to delve into your financials, your reputation and your potential to run the business. The seller will want a copy of your credit report, at a minimum.
Before you seek information about a business, prep your own financial info so you’re ready to make a move when that perfect opportunity presents itself.
After you read our Buying a Business Checklist, you can download BizBuySell’s Guide to Buying a Small Business for more information.
Why You Should Consider Buying an Existing Business
There are lots of advantages you get when you buy an existing business. Think of it as “coming in hot.” You’re not going to have the potential glitches that occur during a new business start.
There are other advantages:
- Business name is established and recognized
- There’s an established customer base and a proven market
- Any issues with zoning and permitting have already been addressed.
- It will be easier for you to get financing if you’re buying an existing business.
6 Steps to Buying a Business
Before you make the decision to buy a business, take a step that isn’t an “action” step. Think about your reasons for wanting to buy a business and what type of business fits your lifestyle.
1. Decide on the Type of Business You Want to Buy
Wouldn’t it be awesome if you could love what you do? A business purchase should suit your goals and style. Agricultural? Construction? Entertainment? Restaurant? Manufacturing? IT? Accounting? Where are your skills?
Are you more suited to be a sole proprietor? Do you want to own a business overseen by executive committees (boards of directors)? Or would you rather oversee a management team? Would you like to be an owner of a seasonal or year-round business? Own a C corp?
Do you want to buy a franchise from its current owner? Keep in mind that the sale must be approved by the original franchisor of the franchise, in most cases. You would be treated as a brand new franchise owner when applying to make the purchase.
And due to our extremely challenging operations during the pandemic, there’s a new question that is of utmost importance: Has this business, or can this business, find a way to operate during Covid restrictions?
2. Begin your Search to Find a Business for Sale
A Business Broker is a type of real estate agent. The Business Broker specializes in commercial properties.
Most even specialize further into types of businesses. For example, there are Business Brokers who handle transactions for manufacturing companies.
If you know where (city, region or state) you’d like to make a business purchase, you can make specific searches there. Find the local Chamber of Commerce or economic development association. Look up local residential real estate companies and see if they also handle commercial properties.
3. Choose the Perfect Business
You could argue that no one would sell the “perfect business” and you’d be – partly – correct. One of the ways to determine whether or not a business entity is “perfect” is to learn the reason it’s for sale.
Here are reasons that may be given for a sale:
- The owner is retiring.
- Owner has health issues.
- Owner has built a successful business and is ready for the next challenge.
4.Go Through Our Buying a Business Checklist
As you move through our buy a business checklist you may run into factors and details about the pending sale that raise red flags:
- The business is struggling.
- The owner is exhausted. This can be good – the business is thriving and the owner can’t maintain the pace. Or this can be bad – the business plan isn’t working because the owner is putting in too many hours.
- The business financial records show a steady downturn or loss. Cash flow is reduced.
- The business is for sale because of a divorce requirement. This can be good – as a couple may hope to quickly sell the business, divide each business share and cut ties. Or, a pending divorce involving an owner or owners can greatly delay the process.
Are there red flags? Problems? But are you still starry eyed with optimism? Bring in an impartial advisor, a friend or trusted business associate. If the red flags are too ominous, go back to Step 2.
5. Secure the Financial Capital: It’s More than Just the Purchase Price When You Buy a Business
Lenders like financing business operations that are already proven money makers when they give a loan to buy a business. That’s one of the reasons that it’s a good decision to buy an existing small business.
Here are places where you may finance the purchases of businesses:
- The business owner – Don’t neglect to ask about seller financing. More often than not, the seller may wish to do financing to negate the potential hit from owing tax on capital gains. Options include: a. Leveraged Buyout – the buyer doesn’t invest as much upfront money and makes scheduled payments, or the buyer can do an assumption of debt on the business assets.
- Your bank.
- The Small Business Association – Through participating banks, the SBA offers a complete menu of loan options. By going through the SBA, you’re involving a bank that has passed muster with the SBA and has experience in all types of business loans.
There are also different types of sales within the sale:
Asset transaction – specific assets are sold after the main sale of the business. This is most commonly done with inventory. The transactions will take place on a time schedule.
Stock transaction – the buyer purchases an ownership stake in the business.
6. Finalize the Business Purchase
Finalizing the sale by signing documents is the last step of the sale process. Get copies of the settlement documents in advance. Check the documents and have your business attorney check them.
Checklist when Buying a Business
Before you commit to the business purchase, research.
Of course you will delve into all the financial records involved with the business operations. But there’s much more to learn before you commit to the sale:
Look into the History – and Future – of Businesses in the Area
Does the type of industry – creative arts, construction, environmental stewardship, hospitality, retail, etc. – thrive in the area?
What about the physical location of the business? What’s the history there? What type of business development is pending in the area?
For example: You’re thinking of buying a manufacturing company that’s so successful, there are three shifts of employees. But a quick search shows you that a huge distribution center, offering higher wages, will be opening in the same county within six months.
Will the employees of your company jump ship? Will you have to offer a better employee wage and benefit package?
Being able to maintain a stable work force is just one of the factors to consider when you’re buying a business.
Know the Status of the Businesses Inventory
The status of the business inventory can be tied to supply agreements. As part of your research check into:
j Material Contracts – A material contract will list penalties if a material is not delivered on time, as specified in the contract. For example, if Company A doesn’t get the white ribbon order from Company B, it can’t complete the July 4 decorations orders. And Company B will pay a penalty.
Supply Agreements – Similar to a material contract. A company has a contract to deliver materials. This can work both ways – the company that’s for sale may have contracted to either provide materials or have materials deliverer to it. Businesses like these agreements because they can create stability in the cash flow.
While you’re checking into business inventory and contracts involving materials and supplies, that’s an opportune time to expand that search. Look into the data entry system used by the company to many inventory and contracts.
Double Check All of the Equipment Assets and Intellectual Property
Equipment for businesses are tangible assets. You can put your finger on them. You can know their purchase price and their value now (after depreciation). You can determine if they are viable to use going forward or are obsolete.
Intellectual property isn’t tangible. It includes things like inventions (which must have a patent), designs and brand names.
The company should also have a logo that’s connected to the brand. The logo is the symbol for the business, and as such it is an asset.
Are all the intellectual properties included in the sale? Will you be able to keep the business’s existing contact information, such as website, FB page, phone number, email address?
Carry Out an Excellent Due Diligence Checklist Process
The Buying a Business due diligence checklist may seem exhausting but it’s not a step to skip, no place for taking shortcuts. By working through the due diligence checklist you’ll verify information and make sure there are no omissions in your due diligence efforts:
- Analyze financial statements and records. In the majority of cases, you’ll need an accountant for this step.
- Review all the contracts that the company has for inventory supplying and purchasing. Review contracts and leases for equipment.
- Research the legal status of the company. Here’s one way to do this – do an online search by typing in the letter “v” and the company name. The “v” is for versus and it’s a common abbreviation when a lawsuit is filed.
- Past history of the business – you can search newspapers and other media for articles about the business.
- Consider Ability to Re-sell the business, if necessary. Doesn’t seem optimistic, does it? But if the business fails, or if it thrives but you’re not satisfied with the venture, you’ll be in a position to sell.
Have a Copy of All Contracts and Legal Documents
Reviewing the details of existing contracts is a hugely important step of the checklist in a business sale. We’ve already mentioned contracts involving inventory. There’s are other contracts and legal documents to review as part of the due diligence process:
Sales representative agreements
Stock purchase agreements
Non-disclosure agreements – these can be for employees and for buyer/seller. Basically, it states no one can reveal trade secrets or customer lists, especially to competitors.
Non-compete agreements – the buyer and seller will not become competitors.
Employees hiring agreements and handbook, may include collective bargaining agreements.
Look at Financial Statements and Sales Records for the Past Three Years
Even if you’re buying a business that is a sole proprietorship, you may need an accountant to go over the details of financial statements and sales records. You need tax returns for the business for the past 3 years.
In addition to tax returns, you should get a copy of the business plan. Do the balance sheets match up with the information in the plan? The best advice is to hire an accountant who can verify that the accounting methods were correct.
Have a List of Debts and Loan Agreements
These often involve inventory and equipment. The current owner of the business may have kept the inventory as a separate asset entity. You should be able to see by looking at business balance sheets.
Will any monies owed on inventory be paid off with the sale proceeds? Or will the debt owed on the inventory be paid off as it is sold (by the new owner)?
Get a Certificate of Good Standing from the Secretary of State
A business should be authorized to do business in the state, which means it is up to date on state fees, taxes and required business filings.
Remember to look further for more information. The Certificate of Good Standing is NOT proof that the business has satisfied all tax obligations.
Find Out Information on Current and Past Advertising Costs
Those costs are a business expense. The costs may have been a lot higher when the business launched.
Do a Valuation and Find Out the Financial Net Worth of the Company
You can calculate the net worth by subtracting the total liabilities from the total assets. This information may be included in analyst reports provided by the seller.
Make sure the method of calculating the valuation is valid. To properly calculate this information, you may need to hire a professional to do the business valuation.
Look at Tax Returns and Credit Reports
You can request the tax returns. You can get credit reports from various entities such as Dun & Bradstreet, Equifax, Experian and others.
View Income Statements
Income statements include revenues and gains, as well as expenses and losses.
Research the Reputation of the Company
Look for the business on the Better Business Bureau website by doing a “who is” search. You can also look at websites such as Yelp, and EDGAR (Electronic Data Gathering, Analysis and Retrieval).
Get a List of Current Employees and Business Structure
You should learn the employees’ hire dates and employment agreements. How is the business structured for operations? Are there team/crews with leaders? Shifts? Supervisors?
Look at the Current Insurance Policies and Look into New Ones
Examples of insurance policies include general liability, commercial property insurance, business income insurance, umbrella policies, auto/fleet insurance, professional liability insurance, worker’s compensation insurance and data breach insurance.
A lot of time, you can transfer the existing policies from seller to new owners. But you may be able to find better rates.
Get the Business Owner to Sign a Letter of Intent
This is a working draft of the final sales agreement with tax settlement documents.
Work Out How Long the Business Could Last and Any Problems
After you’ve made your assessments, bring in an impartial person to review.
Make Sure the Seller Signs an Agreement Not to Compete
The seller agrees not to compete with the “former” business. The agreement can specify a time frame and/or distance for the entities to refrain from becoming competitors.
Check with Local Government About Rules and Requirements
Rules and requirements can include zoning, ordinances and permits. You may have to honor indemnification obligations, which are obligations of the debtor to reimburse a debt.
Find out if the local taxing entities reassess the value of a property based on its sale price. Ouch!
Look at Human Resources Policies and Current Employee Benefits
Policies may cover sick leave policies, vacation time, rules about attendance/working hours, roles and salaries of employees, employees’ job duties by position.
Create a Business Plan
Compare the existing plan to the results. Review and amend as needed.
How long does it take to buy a business?
It can take as long as 8-12 months. You can ask for timely status reports.
What documents should I ask for when buying a business?
Profit and loss statements, last 3 years.
Tax returns, last 3 years
Current balance sheet
How do I buy a small business?
Here’s some advice from the SBA:
Determine your talents and lifestyle
Figure out how much money you can spend
Review the “landscape” for that type of business
What are good questions to ask when buying a business?
Questions to ask yourself: Why do you want to buy this business?
Questions to ask the seller: Why do you want to sell this business? Will you be available as an advisor during the transition?
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