It is a pain ….but oh so important to both parties.
Both Seller and Purchaser have due diligence needs.
From the Seller perspective due diligence is the opportunity to demonstrate their statements of business value are factual. It is also a time where a Seller can confirm the operational and credit worthiness of a Purchaser seeking financing.
From the Purchaser perspective due diligence is the opportunity to ensure the Seller’s statements of business value are factual. It is also a time where the Purchaser is demonstrating their operational and credit worthiness.
Without this confirmation, either party may walk away or need to renegotiate.
For both parties, the process can be challenging, overwhelming. If any one item requested raises a new concern, more material can be requested.
This is a list of often-requested due diligence items and why they are important. In no way should this list be taken as a substitute for employing one’s own professionals for examination, preparation, etc.
Regarding the Purchaser:
Reporting credit worthiness: If asking for Seller financing, the purchaser should produce a net worth statement and credit score. Additional information may be requested to confirm investments, mortgage payments, credit card levels, performance with landlords, and more.
Resume: A report of professional experience that will enable you to run the business.
Regarding the Business
Tax returns: It is thought that tax returns are fairly indicative of the truth of performance. Why would the tax payer (Seller) report more revenue or less expense than is actual? Such reporting could cause the Seller to pay excess tax. Tax returns are often a source for a list of furniture, fixtures, equipment – purchase date and cost. Often the tax return is prepared by a professional who has their own standards.
Profit and loss statements and balance sheets: These often provide more detail in revenue and expense, unlike the tax returns where various lines in both categories are rolled up into single lines. An example is the restaurant where there is revenue income of beverages and food. The profit and loss statement will more likely delineate these. The tax return does not. Monthly profit and loss statements to demonstrate cash flows. The balance sheet can help to lend insight into risks, debt, working capital necessary due to accounts receivable, original cost of furniture, fixtures, and equipment not expensed. It also can be a means for understanding cash flow.
Payroll reports: Such reports, often blinded by name or ss# offer confirmation of pay rates, payroll totals, hours worked, and more.
Sales tax filings (in New Mexico this is Gross Receipts Tax:) Many states and municipalities have sales tax requirements. The business is required to collect the tax and forward it on to the government. The items tax vary greatly from, at least, state to state. This can be a means of verifying sales reported. If the revenue reported on the profit and loss statement or federal/state tax return does not match the sales tax filings including both taxed and non-taxed items, there may be an issue (negative or positive) with cash flow.
Client lists & contracts: The client list and related business done, often blinded by identifying information, can confirm the share of business each client holds. If not the actual contract the contract forms to identify any number of issues for a buyer.
Bank Statements: Most main-street businesses are sold based on cash flow. Bank statements are one additional means of verifying cash flow. Do they reflect the revenue and taxes collected? It is more difficult to make fictitious bank statements than profit and loss statements, balance sheets, and tax returns. Perhaps just the summary sheet(s) can suffice.
Inventory Lists: Often inventory lists are not tackled until closing when the parties sit together and confirm inventory. However, seeing an inventory list in advance, during due diligence, can be a validation of what type is included, if the inventory is not out of date, is reality, is of a magnitude indicated in the marketing package of the business for sale.
Lease: The lease review is confirming what the rent has been, has it been paid in full, are the escalations in rates coming up, etc.
In addition to these standard items, other less-frequent requests include (but are not limited to:) Accounts receivable aging, works in progress reports, vendor contracts, point of sale reports, verification of personal expenses paid by the business, confirmation of expense lines to confirm expenses are fully reported.
Prepare in advance by having your documentation ready and right. Look at the documentation from the other party’s perspective.
Don’t print hard copies if possible. Save a tree. Sharing via Dropbox.com or similar systems helps with volumes.
Have time and energy to focus.
Know why you are asking, don’t just ask because it seems right.
If something does not seem quite right, ask. Many times there is a reasonable answer.
Don’t be offended. It is responsible for the other party to ask.
Don’t go it alone – if you are not a professional in the topic, get a professional.
For many main street businesses the process, if well organized, can take a couple of days. If something is out of whack, it can take weeks, even months, or collapse the deal.
Does it seem as though some items duplicate what others are reporting? Do you double check to see if the stove is off? Validation is important.