Do the financials add up?
One of the main functions of due diligence is for the buyer to look into the financials of the business more deeply. When you make your offer to purchase, you are essentially relying on the numbers provided by the seller, and during due diligence, you have the chance to confirm whether or not those numbers are correct. You can do that by requesting to see whatever financial documents you need to confirm that the numbers they have presented are indeed the numbers they are actually doing. An example of some documents you could request would be: tax returns, profit and loss statements, redacted invoices (normally customer names/contact details won’t be revealed at this point), point of sale reports, and bank statements. Think carefully about why you are requesting to see a specific document or document type. What questions do you have that would be answered by seeing that document or having that data. Have a plan for due diligence in place, so you know exactly what you need to ask for.
Is there a customer concentration issue?
This is probably one of the most important due diligence questions to make sure you have a specific answer to. Finding out whether or not the business has any customers that make up more than 10% of their revenue is really important. You are going to want to ensure that the customer concentration is evenly distributed, because if not, you will risk losing a big chunk of your future revenue if that customer decides not to do business with you.
If there are customers that make up a significant percentage of the business’s annual revenue, you need to dig deeper. How long have they been a customer? Is there a written contract in place that would transfer to the new owner? How confident is the seller that the customer will remain after the sale? Realistically, unless there is a transferable contract in writing, the seller wouldn’t be able to guarantee that the customer will stay with the business post-sale. However, you will have to look at all of the information in front of you and make a decision as to whether or not you think the customer concentration is an issue or not. If it’s not an issue for you, then awesome…you’ve cleared one of the biggest due diligence hurdles.
Is there a vendor or supplier concentration issue?
Another important question to ask the seller during due diligence is regarding vendors and/or suppliers. Are there any vendors or suppliers that make up a large percentage of your inventory or your ability to service your customers? Is the business reliant upon these specific vendors/suppliers or are there alternatives out there that would work just as well? For businesses that truly rely on specific suppliers or vendors, it’s important to understand the relationship between them and the business. Is there a written contract that’s transferable? Would a new owner need to be approved by the suppliers in order to work with them? If so, it might be a good idea to ask your business broker to amend the purchase contract to include a vendor/supplier contingency. That way, should you not be able to work out a new contract with the key vendor or supplier prior to closing, you won’t have to continue with the purchase. Of course, the seller would need to agree to this contingency, but they should do everything in their power to help you get set up with key vendors/suppliers, because it’s their goal to make this business sale happen. In the end, you will need to decide if any vendor/supplier concentration issues could possibly be detrimental to the future of the business. If there are plenty of alternatives out there, then you might decide that it’s worth the risk.
Does the business rely on the current owner or a key employee to operate?
This seems to be an often overlooked topic for first-time and even seasoned buyers. Many people legitimately think that small businesses will just run themselves, and that couldn’t be further from the truth. You really need to take the time to understand exactly what the owner’s role in the business is. Where are they spending their time and what are they doing on a day-to-day basis? Can you easily take over those duties? Because chances are, you will need to be able to jump into their role, especially in the beginning or from time to time as needed. Make sure you are fully prepared to take on the duties of the owner, and don’t rely on simply hiring someone to do the job. Employees can easily come and go, and you will have to be able to carry the business in between employees, if needed. If the business currently relies on a key employee or manager, you should really probe more into that employee as well. How long have they worked for the company? How long have they been in that role? Do they have an employment contract? How much do they get paid? Most sellers will not allow you to meet with employees prior to the closing, but in some cases, key employees might already be aware of the sale, and if that is the case, then it will definitely be advantageous to meet the employee to ensure that they intend to stay with the business after the sale. It’s important for buyers to remember that employees aren’t assets that are sold with the business, and there is no guarantee that they will stay on after the closing date. However, you can do your best to foster that relationship or take the time to really understand their role and responsibilities, just in case you need to assume them as well.
Are you confident moving forward with the purchase?
At the conclusion of your due diligence period, you will need to decide if you are confident moving forward with the purchase. Did the financials add up? Are you ready to jump into the running and operation of this business. Is the business structured in a way (with customers and vendors/suppliers) that you are optimistic about its continued success? Are you more excited about the business than you were when you made the offer? If the answers are positive to all of those questions, then all signs point to you committing to the sale and removing due diligence. If you’ve uncovered some skeletons in the closet or discovered that things just aren’t adding up after a closet look, then it might be time to cancel your contract and get your escrow deposit back. After all, that’s exactly what due diligence is for. It’s for the buyer to have a dig around, take a closer look, and evaluate the business on a deeper level. If after doing that, you don’t like what you see, you can get out of the deal before your due diligence period is up. If everything checks out, and it all gets a thumbs up from you, then happy days, it’s time to press forward with the next aspect of the business sale purchase process.
If buyers have questions about due diligence, or need assistance conducting their due diligence, they are advised to consult with their CPA/accountant on tax and financial matters, as well as their attorney for any legal or business-related issues.