Once you have thoroughly researched and done your homework you have probably narrowed your choices down and found a business for sale that seems like a good prospect to run successfully. Beyond the initial research, once you have settled on one or two choices, do further examination. This is called “due diligence” in the business world, when you and your lawyer thoroughly investigate the business to increase the chances of making the right decision for you. Spend time investigating the business itself, the general industry, and the market forecasts. This will help you feel more confident that you are making the right decision for you in this specific case. There is always a reason why a business is up for sale; your research will hopefully reveal those reasons. There could be a cash-flow problem, the company could be suffering from toxic or bad management, or the business could be suffering because of a poor economy. Once you have done your homework regarding the reasons behind the business’ sale, you can weigh the pros and cons from an informed stance.
Sometimes you must sign a letter of intent before the seller will release sensitive information about the business to you. A letter of intent is a non-binding offer to purchase the business. The letter of intent also acts as a confidentiality agreement assuring the seller that you will not use the information that they release to you towards any purpose other than deciding whether or not to buy the business. This gives the seller more confidence in your intent to buy.
The Business Investigation
A business investigation is performed before the business is purchased. But, the process of investigating the business can continue after the sale as well. In such cases, some of the sales proceeds are held in escrow pending the resolution of the investigation, or the contract can provide for this and indicate that the seller is required to reimburse the buyer if certain, specific issues crop up. The business investigation is an objective examination of every single aspect of the business and involves having a good, hard, realistic look at the current fiscal and organizational situation of the business in question. Many times, time does not allow for an investigation that is as thorough as the buyer would prefer. Certain basic inquiries need to be made, though, and we shall examine each of these in turn.
1.Tax returns: tax returns are a great source of information. Secure an accountant to go over these documents with you, and request at least three years worth of returns; request returns from even further in the past, if at all possible. This will help determine business profitability and if there is any outstanding tax liabilities that the buyer should be concerned about.
2.Organizational documents: documents that illustrate the methods used to organize the business, for example partnership agreements, articles of incorporation, or business certificates, should be thoroughly examined to determine what methods are used to structure the business and how the business is capitalized.
3.Financial statements: As with tax returns, request the financial statements for the previous three years at the very least, longer if at all possible, to determine the general financial condition of the business in question.
4.Contracts and leases: Leases for property or machinery, contracts of sales, and contracts of purchases should be pulled and examined so that the buyer can understand the exact obligations that the business is subject to.
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