Buying a business has many challenges not the least of which is the due diligence process prior to the closing of the purchase. Most small business owners run their business with no thought of selling it. Their record keeping and bookkeeping are done for their needs and there is little or no thought given to how a buyer would view their information.
When buying a business Due Diligence has 4 basic areas of focus. Three of the four require the assistance of the seller:
- Industry Due Diligence: The seller is often the worst source for this information. Many small business owners have no real idea of the industry outside the 4 walls of their business. Get what you can from the seller but be prepared to conduct your industry due diligence with outside resources. Most industries have Trade Associations that can be a good source of information. Here’s a link to a Directory of Trade Associations
- Business Operational Due Diligence: This is where the seller has the most information. They usually can give you, the business buyer, every detail of the business process. During due diligence focus on understanding why the seller does something their way. Also, you will likely find that the business seller has not documented their processes very well or more likely not at all. When discuss operations with the seller try to take all the notes you can so that you can get focused on the critical areas you need to understand. You’ll have plenty of time later to figure out if you want to change something. Keep in mind that you will be replacing the owner so spending time focusing on what the seller actually does day to day is important. You might want to start a specific list and identify evey seller’s duty – daily, weekley, monthly, annually.
- Financial Due Diligence: This is the wild card. Different seller’s are all over the place on this. I’ve seen million dollar businesses run from a shoe box and $50,000 businesses with perfect accounting. Don’t focus on how they keep their books, just focus on how you can determine from their books if the information is reasonably accurate and you can determine how much money the business is actually making. Most small business financial due diligence starts with bank accounts. Do the deposits made at the bank equal the sales reported for the business? If not, why? Once you pull on that thread it will lead you to other questions.
- Technology & Intellectual Property Due Diligence – This is an area of rapidly growing importance. When buying a business make sure that the asset is owned by the seller. there are some obscure laws about who actually owns intellectual property once it’s produced. Also, often I.T. systems are licenses and not assets that themselves can be sold. Do some homework in this area and it could save you some headaches down the road.
We have a saying when buying a business, “There are good businesses with bad books, good businesses with good books, bad businesses with bad books and bad businesses with good books”. Make sure your due diligence helps you determine which kind of business you are evaluating. Understand the bookkeeping situation but don’t let that automatically disqualify a business for possible purchase.
Keep in mind that your goal is to buy a good business, not just buy a good bookkeeping system.