Why is due diligence important when buying a business?

Why is due diligence important when buying business?

Due diligence is important and a key part of buying a business. The due diligence process allows the buyer to investigate all areas of the business and assess the value of the business based on that information.

Due diligence can help you to make an informed decision on the whether to proceed with buying a business based on the due diligence report.

Prospective buyers should undertake thorough due diligence of any target business that they are considering buying.

Due diligence plays a crucial role in any business acquisition process and can be the difference between a successful acquisition and a bad acquisition.

In this blog we answer many of the frequently asked questions about due diligence and the benefits it brings to any transaction. Carry on reading to find out...

What is due diligence?

Due diligence is a vital step that you should undertake if you are looking to buy another business or invest in another business.

It is a detailed investigation of a target company and provides verification, reassurance of the company you are considering purchasing or investing in.

It will help you to gather all the relevant facts about key areas of the target business including areas such as financial statements, legal, corporate structure and operational areas.

As a prospective buyer or investor, you should ensure that you employ professionals to undertake a thorough review on your behalf.

How long does the process take?

The length of the due diligence exercise can vary depending on the size and complexity of the target business.

The due diligence process can continue throughout the time of the deal, but it is better to get due diligence underway at the very start of a potential transaction to ensure you are identifying any issues before you are too far through the acquisition process.

Normally a due diligence information request or due diligence questionnaire is sent to the target company as soon as heads of terms or a letter of intent has been signed by the parties involved.

If the due diligence exercise can't be finalised before completion, then your advisors can request other forms of protection such as purchase price retention, where you retain an agreed part of the purchase price until completion and can negotiate if anything is highlighted.

What do you look for in due diligence when buying a business?

There are some main areas of a due diligence review that need to be undertaken when buying a business, these are:

Financial due diligence

A typical financial due diligence review will look at all financial aspects of the business. This will include both the past financial performance and the forecast financial performance.

Financial due diligence is a key aspect of any purchase, and it should provide a true and fair view of the target business and whether the price you are paying is justified.

Legal due diligence

Legal due diligence generally covers an investigation into areas such as the corporate and legal structure, employment contracts, contracts with suppliers and customers, intellectual property rights, health and safety, regulatory compliance, litigation, tax and property.

Operational due diligence

This will assess the strength and weaknesses of the business operations including IT and systems, people, logistics, supply chain, business processes, sales, marketing and future potential. It will highlight if any operational issues are present in the company.

Cultural due diligence

So often in a deal the one area that isn't considered enough is around cultural fit.

Focusing only on finances, legal, operations and not considering the cultural fit of both companies that can potentially create problems post deal.

It is worth looking at not only the cultural fit of people within the business but also with customers as well.

What are the benefits?

Prospective buyers will benefit from well conducted due diligence. It will minimise risk in the deal, and protect you as a buyer from potential issues in the deal later down the line.

The benefits of good due diligence are:

• Provides expert third party insight into the target company.

• Provides transparency for both parties in the transaction.

• Gives clarity of whether the financials of the business are a true and fair view.

• Can minimise legacy issues post deal.

• Helps to identify and manage risks.

• Could lead to you negotiating a lower price and getting a better deal.

• Can save you valuable time later in the deal.

• Can ensure a stronger deal and smoother transaction.

• Allows you to decide if the target company is the right fit.

• Can improve relationships between the two companies.

Why is due diligence different for buyers to sellers?

You can clearly see why as a buyer you would undertake a due diligence review on a potential target business.

However, if you are considering selling your company, then it may be worth undertaking seller due diligence before you begin a sale process.

This means collecting all the information which a potential buyer is likely to consider in their due diligence process, making sure it is complete and accurate and you will be presenting it in the way that is most favorable to your business.

Conducting your own due diligence even before you consider selling your business prepares you for any purchaser questions.

It may highlight any issues that you can tackle prior to sale and will allow you to present your business in the most favorable way possible, ensuring you get the best price for your business.

The importance of due diligence in a business acquisition or investment

Businesses looking to acquire, should spend adequate time and budget on a thorough due diligence process.

I can't stress enough the importance of good due diligence in any business acquisition, business sale, share purchase or investment opportunity.

Summary

Accountants are well placed to undertake much of the due diligence process for you, give you advice on how to proceed and will handle much of the business purchase process for you.

Identifying potential risk early in any transaction will allow you to tackle those areas prior to any transaction being completed and may mean a better and more secure deal later down the line.

If you are thinking of acquiring another business, considering selling your business or have an opportunity to purchase shares or invest in another business and need some help and advice with the due diligence process, then contact us today.