Nuts & Bolts to Due Diligence

What are the nuts and bolts of doing Due Diligence on a Business Opportunity? Of course this answer varies from business to business. In this post, we will discuss doing due diligence on B2B (Business to Business, i.e. Non-retail) businesses, such as manufacturers, service businesses and Distribution businesses. Naturally, you need to consult with legal and financial professionals in the process of doing due diligence, and even before you start.

This post is informational in nature, and can not be construed as legal advice.  Consult an attorney.

Protect Company & Trade Secrets

A manufacturing business is usually in a very small community of vendors & customers, so expect the seller(s) to be cautious and careful with sensitive information. This is something you need to work with. Examples of a seller protecting sensitive information include redacting names of customers and key suppliers, barring contact with key employees and withholding manufacturing processes. Sellers are wise to protect trade secrets until there is a firm commitment from a buyer. Otherwise, they run the risk of losing a competitive advantage. What you should expect upfront are financials.

Request & Review thorough Business Financials (Tax Returns, P&Ls etc)

What does ‘financials’ mean? At the minimum, you should look for at least Three (3) years of Business Tax Returns, Corresponding Income Statements & Balance Sheets and a Year To Date (YTD) Income Statement with corresponding Balance Sheet. It is not unusual to ask for up to five or more years of financials depending on the circumstances. Financials aren’t just limited to Tax Returns and Income Statements though. You should also get other relevant financial metrics such as Sales by customer, Payments to Vendors, detailed payroll information, Accounts Receivable and Accounts Payable etc. Expect that this information will be redacted, until the transaction is out of contingencies.

Verify Financials using IRS Form 4506

Once you have all of this information, you need to analyze it and it is strongly recommended to have them professionally analyzed by a forensic accountant or other specialist. This is key, you need to be able to identify trends to help you corroborate the story you have been given by the seller. You can also request the seller to fill out the IRS Form 4506 so you can request certified copies of Tax Returns that have been filed with the IRS from the IRS. Just because you were given Tax Returns by the seller, doesn’t mean that they were the Returns that were actually filed with the IRS.

Business Standing with Regulatory Agencies

While you are reviewing the financials, you need to be investigating other items. One other item to stay on top of are the compliance standings with all of the government and other regulatory agencies. You want to make sure that the business is in good standing with all agencies and entities. If not, figure out the problems and see if you are up to solving them, or if the seller can or will solve them prior to you taking possession of the business. If there are issues that need to be solved, then you need to determine the amount of money that is going to be required. This can be a figure you can use to adjust the agreed upon terms of sale. Just remember, some problems often take longer than expected and more capital than expected to rectify. So, if there are problems you may want to consider canceling the transaction and moving on.

Customer & Vendor Satisfaction with Business

Aside from Regulatory issues, you need to look out for customers or vendors that may on the verge of discontinuing doing business with the business. One way you can determine this is to look at customer history on a monthly basis and historical Accounts Receivable information and looking for fluctuations, including decreasing trends. You need to get the seller statements about the business in writing.  Business Intermediaries that are members of The California Association of Business Brokers have access to a Seller Disclosure Form that can be used to get the important questions about the business answered by the seller in writing. For example, these seller disclosure forms ask about customer concentration, any special relationships with vendors and customers and if there are any regulatory issues. This disclosure form can be handy to use against a seller if it turns out that there was deception or misrepresentation. Keep in mind, that you would rather find out the problems and pull the plug on the deal rather than attempt for a remedy months after taking over. So be thorough.

For more information about Due Diligence Services Contact our Client Care Manager, Sonia Chhabra, at  (888) 926-9193 or by email cs@justelementary.com