What am I Buying: Due Diligence
What is Due Diligence

The term "due diligence" is synonymous with "background check" and refers to the period during which buyers make sure they have all the information they need to proceed with the transaction. At this point buyers are focused on a particular business they are seriously interested in purchasing. Note that there is no set amount of time that must pass during due diligence - take as long as you need to answer all of your questions.

If you haven't covered them already, you should examine the following areas during the due diligence period:

Personnel. Review employees' skills, experience, wages and salaries, payroll procedures and other relevant human resources issues.

Financial operations. Examine the company's books and records, as well as all accounting and bookkeeping methods. Analyze cash flows, both present and projected. Look at accounts receivables. Consider debt and bank or lender relations. Consider services and product pricing and its consistency with industry standards.

Marketing. Examine the company's advertising campaigns and public relations programs (if any). Analyze marketing and sales strategies. Look at how your competition markets and advertises their products.

Property/equipment. Review all appropriate leases and/or deeds. Conduct appraisals for all equipment and assets. Consider depreciation in property and equipment values.

Business operations. Consider location, inventories, vendors, suppliers, management, customer relations, insurance policies and any other topics specifically related to the business you are considering buying.

Why do Due Diligence?

Buying a business is an arduous, yet potentially rewarding process, and can take weeks or months. Because buying a business will involve investing a fair amount of money and time, it is critical to do your homework when gathering information about the business. This process is commonly referred to as conducting due diligence. In most purchases of small businesses, the buyer will want to learn everything possible about a business before signing the purchase agreement. (Alternatively, if there isn't time to do that, then the buyer will want to make sure that the representations of the vendor concerning the business are quite comprehensive and that the definitive agreement allows him to back out of the deal if the due diligence done after signing the definitive agreement is not satisfactory).

Why do due diligence?

Conducting proper due diligence will help the buyer avoid the following problems:

• Purchase price of the business turns out to be too high.

• Misunderstandings as to the type and condition of the business being bought.
  
  
• Bad financial situation.
  
  
• Bad management.
  
  
• Pending lawsuits.
  
  
• Contingent liabilities.
  
  

Doing your homework

Following is a list of some of the main documents you should expect to receive in the course of your due diligence:

• Key contracts.

• Financial statements.
  
  
• Customer lists.
  
  
• Employment agreements.
  
  
• Minutes and consents of the board of directors and shareholders.
  
  
• Confidentiality and Invention Assignment Agreements with employees.
  
  
• Corporate charter and bylaws.
  
  
• Litigation-related documents
  
  
• Patents, copyrights, and other intellectual property-related documents
  
  
• Licenses and permits related to operation of the business