I could fill this article with horror stories about purchasers who have bought businesses without doing a proper due diligence before signing a contract to buy a business. My experience as a solicitor and mediator has exposed me to that. But I am not a negative person. With proper investigation and advice you will quickly establish whether the business is a dud or a viable investment.
There are many precautionary steps that you should take take to minimize your risk and increase the opportunity of obtaining a fair return on your investment. Specific advice must be obtained. An accountant is not qualified to give legal advice and neither may a lawyer give financial advice.
What would a general financial due diligence investigation involve?
The business’s audited financial records for the past 3 years must be analyzed .These must be provided by the Vendor’s accountant for your accountant to review. Your accountant would usually require the profit and loss statement and balance sheet, income tax returns, Business Activity Statements and proof of payment of GST. Remember that some vendors often try and explain away discrepancies by reassuring a buyer that a portion of sales are not reflected “on the books”. Be wary of the obvious risks in these circumstances. You will have no comeback if the extra sales don’t materialize.
It is also essential to obtain employee records, a typical roster, wage details and proof of wages and details of equipment leases and maintenance records. Invoices for the most recent three month period must be available for review to verify purchases.
The above information will at least enable an accountant experienced in businesses transactions to analyze the information and build a financial profile of the business and to advise on the soundness of the representations made. An assessment can then be made as to the extent to which the asking price is realistic having regard to the profitability of the business – or whether you should negotiate a better price, or walk away.
What would a general and legal due diligence investigation involve?
Enquiries should always be made about the reason for the sale. For example, if it’s a cafe, the vendor may know that a major tenant in the office block where the café is situated may be moving out and want a quick sale. Or, the vendor may be selling because new competitors are entering the neighborhood. Generally, this information can be obtained from the local council.
Customers and suppliers should be contacted. They could be a good source of information about a business and its problems.
A legal due diligence will involve an examination of the lease to establish the rights of occupancy, that the vendor is not in breach of its lease, that all options for further terms are valid or have been validly exercised and that there is enough time on the lease to justify paying the purchase price. You do not want to acquire a business with “fatal” lease issues. If it’s a franchise business a careful review of all of the franchise documentation is necessary too.
Other important matters that would form part of a legal due diligence include reviewing regulations covering the business operation and establishing whether the relevant permits, trademarks, business names and licenses that the business needs to operate, are valid and are capable of being transferred to the purchaser.
Now I couldn’t possibly in this short article deal with each and every aspect that I as a solicitor would cover in a legal due diligence and in negotiating a contract of sale (there are many protections that would also be incorporated in the contract too), but I would be happy to discuss that with anyone needing further information.
So, if an opportunity arises, don’t get blinded by the bright lights. Head for some independent advice from experienced people before putting pen to paper. It could be the best money you ever spend.
Jonathan Kaplan is a commercial lawyer, former owner of several retail businesses and an Accredited Specialist Mediator. Full contact details may be obtained from his website at: www.kaplanlaw.com.au.
The advice and information contained in this article is of a general nature only and is not intended to constitute or substitute professional advice.