Buying a Business

6. Detailed Due Diligence

After signing the Heads of Terms, you should make a thorough examination of the business. This is the second stage of due diligence.

6.1 Seek out customer's opinions. Ask them:

• How long have they been customers?
• Who is their main contact at the business?If this is the owner, his continued involvement will be more valuable.
• What is good and bad about the business's products or services?
• Do they use competitors? What are their comparative advantages?
• What will the customer's future demand be for the business's products or services?

6.2 Ask suppliers for their views.

• Does the business pay on time?
• Is it an efficiently run business?
• How does it compare with competitors?

6.3 Analyse historical information and trends.

• Look at sales growth, profit margins, overheads and working capital (debtors, creditors, stock and work-in-progress).What is the scope for improvement?
• Check for inconsistencies. For example, the business may recently have changed its accounting policy to increase the book value of stock (and therefore profits).

6.4 Compare the business' financial projections with other evidence you have.

• Do they tally with the historical trends?For example, are the debtor period and the bad debt provisions realistic?
• Is the sales forecast achievable, given the current orderbook and the statements by customers? Does it reflect the outlook for the industry and the whole economy?

6.5 Check up on major balance sheet items.

• When was the last full audit? If it was over six months ago, do another one.
• What are stock levels?Rising stock levels may be a dangerous sign, especially in manufacturing, seasonal or fashion industries.
• How large are the business' bad debts?

6.6 Consider doing an employee audit, if you are allowed access to the business. This involves looking at:

• Who the key employees are, so you can plan how to run the business.
• General skill levels, employee turnover, and pay, compared with industry averages.
• How employees feel about a change of ownership. Would you expect any to leave? If so, would the key people stay?

6.7 Complete legal due diligence.

• Confirm legal ownership of all key assets.This might include property, equipment, vehicles and intellectual property (eg registered patents, copyright).
• Check for any past, current or pending law suits.
• Examine all contractual obligations.This includes employment contracts (including any pensions), and contracts with third parties, such as customers and suppliers. Look for contingent liabilities.Consider what effect a change of ownership will have. Some contracts may be nullified as a result.