We have all heard of the horror stories of business purchases that have gone wrong. The business does not generate the profit shown in the figures. The new owners are left struggling with debt. Could this have been avoided? Yes indeed! Effective due diligence can uncover overpriced businesses. It can reveal risks that can cause a business to unravel after you purchase it.
Due diligence is the process of looking in more detail at all areas of the business for risks and to assess the long term viability.
Firstly you need to determine whether you are a builder or an entrepreneur. The due diligence for the builders is about eliminating risk and ensuring the business is strong. Due diligence for the entrepreneur also involves looking for those opportunities for quantum growth and assessing how well placed is the business to capture those opportunities.
You also need to clarify whether you are buying the business or the company that owns the business. The level of due diligence will be different if you are buying the shares in the business. The common practice is to buy the business and not the shares as this way you are not responsible for problems prior to your ownership.
It is wise to undertake due diligence at 2 levels. Firstly at an initial level that provides enough detail to be able to be able to know what price to offer and how to structure the offer.
The price you offer is a multiple of the profit the business makes. Obviously the higher the multiple the more you will pay for the business. Your initial due diligence should reveal such things as a downward trend in income or margins. It may reveal sharp recent increases in costs, such as rent. Such discoveries may mean a reduction in the price.
Your initial due diligence may also reveal a heavy dependency on the owner. Take the owner out, and the business may fall apart. A way to buy the business and mitigate against this risk is to have a staggered payment for the business, based on how it performs. This also locks the owner in to ensure the business does well during the transition.
Once the basic terms of the sale are agreed you can then undertake detailed due diligence. You start with a good checklist that covers all the aspects of the business. It starts with the financial side to check the accuracy of the figures and looking for trends in the figures that could point to a change. It uncovers whether there are related entities distorting the reliability of the figures.
Due diligence involves looking at the customers, to see if there is a good spread, good quality and demographics. At the end of the day it is really the customers you are buying.
On-site inspection is important to understand the operation and to ensure there is alignment between the documents and the operation.
Buying a business is one of the biggest investments you will make and one of the most difficult to assess. Investing in professional help is essential. Fail to do this and you may lose even more than the money you pay for the business.
Peter Ambrosiussen is the principal of Ambrosiussen Accountants & Advisors www.ambrosiussen.com.au
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Published by Toowoomba Chronicle www.thechronicle.com.au on Saturday 14 December 2013