Don’t buy a lemon

Michelle Malcolm explains the importance of a thorough due diligence process when buying a business.

Recently I was approached by an enthusiastic couple who had just bought their first business. They asked me to be their accountant and threw themselves energetically into their new venture. When we met again three months later they were disheartened that all their hard work was not translating into the revenue and profit they had expected. When we investigated further, we found some anomalies relating to the previous owner. These would have been identified if a thorough due diligence process had been carried out prior to purchase and could have saved the buyers several hundred thousands of dollars.
So what is due diligence? Assessing the sale price and information presented by the seller to:
• Make sure it stacks up.
• Ensure the price is reasonable and the assumptions are correct.
• Identify additional information that can assist you with your purchasing decision.
It’s not a question of whether or not to do due diligence, but instead to what scale it should be done. There are a number of key benefits that to from a thorough due diligence process.
The first is to determine whether or not to proceed with the transaction.
People tend to buy emotionally and then justify rationally, after the event. If you’re thinking of buying a business, then engaging the right team of advisers to assist is critical. Objectivity can help you make a better decision. It’s worth factoring in the investment as it will be better and cheaper than getting the purchase wrong.
Choose advisers who have the skills, commercial nous and experience, to objectively review the information and advise accordingly. There are three areas to consider: legal; financial; commercial.
Gaining external expertise in each area is recommended, but before you do that document your vision for the business; your role; and how much you expect to pay for the business and the returns you expect. Be realistic, as 40 percent of business owners do not improve on the previous owner’s financial performance.
Document what you consider to be the critical success factors for the business and determine whether you have the right skills to make it happen.
The due diligence process is best approached by addressing all areas within the business with your team of trusted advisers:
• Identify what information is available.
• Evaluate the reliability of that information.
• Review trends in the information.
• Evaluate the financial impact of trends and borrowings.
• Review legal contracts with suppliers, customers, landlord(s) and staff.
• Use your adviser’s knowledge to structure and influence the deal in the most efficient way.
• Identify issues to ensure that costs are minimised and exposure is limited.
• Review if the goals of the transaction will be met.
• Understand where value will be created. What is the ‘magic’ of the business, what makes it special and what will be its sustainable competitive advantage.
• Understand the organisation chart for the business and employees who are key to the ongoing success of the business.
• Understand all risks within the business: e.g. owner’s relationship with customers and suppliers, age of client base, key personnel, length of lease.
• Conduct a TWOS analysis. (Sometimes called a SWOT analysis but it’s better doing it in this order when evaluating a purchase).
• Develop a success plan for integrating the business and/or managing change for all stakeholders.
Due diligence gives you objectivity, insight and certainty to aid your purchasing decision. The only lemon you’ll want is the one in your drink after you’ve made your purchasing decision.