Buyers who purchase companies without doing due diligence often find
themselves saying: “If only I had known.” If only they had known about those
payroll tax penalties. If only they had known
about a burdensome pension plan. If only
they had known that a majority customer
would leave after the business transferred.
“The purpose of due diligence is threefold,”
says Patricia Rubin, CPA, a director in the
assurance services department for SS&G
Financial Services, Inc. “First, we find information about prospective companies that
will help buyers run the business after the
deal closes. Second, we identify problems
that could delay closing. Third, we determine
issues that could impact the purchase price.”
Due diligence answers common-sense
questions about a business being considered
for purchase. In the heat of negotiations and
drafting letters of intent, many business owners neglect to ask the basics. Due diligence
exposes all the numbers, human resource
issues and key factors a buyer must know
about a business before buying it.
Smart Business spoke with Rubin about
the due diligence process and what to watch
for during the process.
What are the stages of a business purchase,
and when should due diligence begin?
It all begins with the search process and
seeking out a viable business for purchase.
From there, you determine a reasonable purchase price and make an offer. Once a price
consensus is reached, a letter of intent is
drafted and signed by both parties. At this
point, you should contact a professional to
perform due diligence. Generally, you have a
30- to 45-day window for this process, during
which a purchase contract is drafted and
negotiated. Once due diligence is complete,
the purchase contract may be renegotiated to
reflect any findings, and then financing is
finalized and the deal closes. Due diligence is
a critical part of the purchase process. Once
you own the business, you own its mistakes.
How will a hired professional begin the due
diligence process?
First, the professional you hire will gather
information about the business for sale and
its industry. We start with a general list of procedures and customize this process to fit the
business, always asking the question: What is
important to the deal? That varies from business to business. Where revenue may be critical to one deal, expenses may be more
important to another. We determine what
items require more investigation — where do
we need to dig deeper so you will understand
the business better once you own it? Due diligence often gets started after-hours or on
weekends because many company owners
do not reveal to employees that the business
is for sale. The due diligence process also
requires working with the seller to determine
the following: Who manages accounting at
the business, is quality financial reporting in
place and what customers are important to
retaining sales levels? Other questions we
ask include: Has inventory been consistently
valued? What is included in accounts receivable and payable agings? How up to date is
the equipment? The list continues and varies
depending on the type of business.
Can due diligence findings affect purchase
contract negotiations?
We may learn that a seller’s attractive financial results are the result of inconsistent
accounting practices, such as deferring expenses to make the company look more
profitable on a continued basis or pooling
revenue into one year to the detriment of
another year. These practices can affect the
value of the company and, therefore, what
you should pay for it. Or, we may learn that a
company is dependent on a particular customer. In that case, the buyer should confirm
that the customer will stay with the company
when the business changes hands. We try to
identify issues during due diligence so you do
not find out about them after the sale.
How can due diligence provide buyers with
important post-sale knowledge?
We often identify integration issues. In
other words, we consider everything you
should know about the business after you
own it. For instance, are the accounting personnel competent and will they be dedicated
to the new owners? In instances when a division of a company is for sale, that division
may have always relied on the parent company to do its accounting. In that case, it may
require additional assistance to manage
banking, accounting systems and payroll processing after the sale. Also, a division may not
have any tax reporting responsibilities.
Are there any deal-breakers that buyers
should avoid?
Warning signs often light up during due diligence — that is the point of the process. One
major red flag is if a seller cannot answer routine questions about the business. The seller
should know how the company reconciles its
accounts and how much inventory it has at
any given time. Review the seller’s financial
records. They should be concise and up-to-date. Find out if the company has payroll tax
problems. Ask whether the company has lost
any customers in recent years and why.
Check accounts payable agings to learn
whether bills are paid on time. Examine the
condition of equipment. Ask yourself every
what-if question possible, and bring these
inquiries to the table before signing the purchase contract. Due diligence is a learning
experience and if what you discover is bad
news, you will be glad you didn’t skip it.
PATRICIA RUBIN, CPA, is a director in the assurance services department at SS&G Financial Services, Inc. (www.SSandG.com). Reach
her at (800) 869-1835 or [email protected].
