You’ve probably heard about ‘due diligence’ when a business is being sold or taken over and wondered what it meant.

If you want to sell or buy a business of your own you certainly need to know just what due diligence means and how it’s applied.

What is due diligence?

In its simplest form due diligence is a comprehensive process that investigates every aspect of a business. The objective is for the intending purchaser to ensure that all facts and financial figures are as stated by the vendor. You need to make sure there are no unpleasant and unwanted surprises that have been concealed. It is a part of every business sale or purchase, regardless of the size of the enterprise.

The more complex the business is, the longer the due diligence is likely to take.  A purchaser shouldn’t commit to a purchase contract for a business until it has been completed. Is this a good business?

What does it cover?

Due diligence is conducted to answer a number of questions. These include whether the timing is appropriate for the purchaser to buy and why the vendor is selling the business. You need to make sure the business has not peaked and is starting to slide. This might make it affordable but also means it isn’t capable of improvement and could represent a bad investments the purchaser.

How are its finances?

Every business for sale comes with claims of turnover, expenses and profitability, but the purchaser needs to investigate that these are accurate representations.

Due diligence inspects the books of the business including tax records for normally up to the previous three years to validate or challenge claims by the vendor.

Who are its suppliers and customers?

Due diligence examines all existing supplier contracts and sales agreements. If necessary new agreements to carry suppliers and customers over to the new owner may need to be introduced.

It should also verify the background and claimed purchase levels from key suppliers and of key customers and evaluate growth potential where required.

What’s the condition of the premises?

The acquisition of most businesses involves taking over premises, usually ones that are being leased by the former owner. The due diligence process looks at the condition of the premises so that the purchaser is aware of the potential need for repairs. It investigates the terms of the lease to ensure it’s sufficiently long and the rental amount is appropriate.

Is it compliant with legislation?

Due diligence identifies all the permits required by the business being offered for sale and ascertain whether the company is in full compliance. It also examines proposed or pending legislation to ensure that no changes to the regulatory environment will affect the business.

How good are its people?

People are essential to most businesses. Due diligence examines the staffing of the enterprise and whether the people now in the business will remain there under the new owner. It also considers future staffing requirements and any need for redundancies of existing staff and estimated costs to the business.

What’s the IP worth?

Due diligence establishes the validity of all Intellectual Property that is included in the sale and ensures that it is transferred along with other assets required for the continued smooth operation of the business.

How does the ownership change?

Due diligence establishes whether the outgoing owner needs to remain with the business for a period of time to assist the new owner. It should also include confirming an appropriate length of time in which the previous owner is restrained, i.e. ‘locked out’ of competition with their former firm.

Due diligence is an essential yet flexible process that every purchaser needs to understand and incorporate into the purchase of a business.

It normally takes place after an offer has been made and accepted, but it can be used to help the purchaser determine or finalise the most appropriate price to pay for the business.