Due Diligence - The Basics
Due Diligence is the period when you will be able to
access the company's books and records to verify that
all of the information that you have been told thus far
is true and accurate. Most often, people unwisely believe
that Due diligence is simply the time to verify the financial
position of the company. While this is true to some extent,
a proper and effective Due Diligence goes past the financials.
The Right Approach To Due Diligence
Is this the time to look for things that are wrong with
the business? Is this the time to strictly verify numbers?
Is this the time to disprove what you have been told by
the entrepreneur? While each of these approaches is somewhat
valid none are absolute. You will want to employ a part
of each of these strategies but an effective Due Diligence
is when you can really "check things out". Use
this period to determine whether the future looks bright
for the business and the industry. To do so, you must
investigate far more than the financial aspect. Sure,
the various financial statements will give you a picture
of the past and perhaps a glimpse of the future but the
past is over and done with. You must thoroughly review
the company's sales, marketing, employees, contracts,
customers, competition, systems, suppliers, and legal
and corporate issues. You want to complete the Due diligence
period knowing exactly what you are getting into, what
needs to be fixed, what the costs are to fix them and
if you are the right person to be at the helm to put the
plans in place to make a great future for the business.
How Long Do You Need
Every entrepreneur will try to negotiate the shortest
Due Diligence period possible. It is impossible to truly
get a feel for a business in a short time. You need at
least 30 days (20 working days) for even the smallest
of companies. Since a proper investigation reaches farther
than just financials you must allow yourself adequate
time to accumulate the information. This strategy lends
itself to wondering how to get the entrepreneur to agree
to this time frame. It's actually quite easy; let them
know exactly what it is that you will be investigating.
Tell them that you do not want to back out of the deal
and if they truly want to move forward with it they must
allow you the time to do the proper investigation.
Your preparation must begin the moment you believe that
the business may be worth pursuing. After you meet the
owner the first time and believe that you may be interested
you should begin to organize your plan. No matter how
early you are in negotiations, at least start think of
what you need to do. Start lists and note areas and specific
details related to the business that need further review.
Once you get closer to a deal keep detailed "to do"
lists, broken down by each sector of the business (i.e.
Financials, Employees, Sales, Contracts, etc.). Keep your
accountant informed of when you anticipate beginning the
Due Diligence. Assemble lists of the materials you will
need from the company and never begin the Due Diligence
until you have received all of the supporting documents
that you will need from the entrepreneur.
Should You Hire An Accountant To Help You?
Without question you should use an accountant for this.
Even if you are an expert in this area, get an accountant
to run the numbers and verify all of the financial activity.
There is so much more that has to be investigated that
your time is best spent on these areas and you would better
hire a professional to help with the financials.
Getting The Entrepreneur and Their Staff To Cooperate
The entrepreneur must let his people know that they are
to provide you with full access to all files and complete
cooperation throughout your investigation. That's your
job. If there is anything that they do not want you to
see, then tell them to remove it from the premises.
What If You Find Surprises?
This should probably be titled: "What to do "WHEN"
you find surprises" because you will. If you don't, you haven't
looked hard enough. Deal with each on it's own and make sure that
you thoroughly investigate each so that your facts are bulletproof.
However, don't get bogged down with minor issues and you are best
to take these as "part of the package". Unless you find
something that cannot be resolved or is so detrimental that even
if the seller lowered the price by 50% you would still have to
walk away you are best to take all of these obstacles in stride.
Don't publicize them; investigate them. A few issues doesn't mean
that the business is bad. You must weigh them impact against the
future viability of the business. Remember your goal is to learn
what it is you will be getting into and what the future can be
with you in charge. The option always exists for you to renegotiate
once your investigation is completed. You will be in a much stronger
position if you can go to the entrepreneur with very specific
concerns, which require reevaluation and renegotiation. With this
in mind, do not discuss your findings with anyone except your
accountant or other advisors.