Growing Your Business

5 Due Diligence Steps to Take When Buying a Business

by
Julie Farless
on
7/7/2016
5 Due Diligence Steps to Take When Buying a Business

Buying a business is no small investment. Before you sign on the dotted line and take on the business for better or worse, you need to make sure you are not only purchasing a viable company that will prove profitable, but also that you are paying the right price for the company.

For this reason, thorough due diligence is essential prior to any transaction involving the purchase. To ensure that your investment is a wise one, follow these five due diligence steps.

 1. Verify and audit the business' financials.

 Financial evaluation is one of the most important components of the due diligence process. The goal of this evaluation is to verify all of the information that has been provided to you and ensure that the business will be a sound financial investment.

During this part of the process, you may have the business's financial statements audited by a third party. This audit will provide you with an unbiased opinion of whether the business's financial statements are an accurate reflection of the business's financial situation and performance over a given period.

You may also review the documents yourself, paying careful attention to the businesses historical sales, operating expenses, forecasts, working capital requirements and accounting systems.

When looking at a cash business, be careful that you can verify what the seller is attributing to the business. You might need to get creative. For example, if purchasing a coin operated laundry, you might need to look at the electrical and water bills to validate sales.

 2. Review all vendor and customer contracts.

 After you have evaluated the business's financial documents, the next step in the due diligence process involves reviewing vendor and customer contracts carefully. Check first that the contract can be assigned to you as the new buyer. The business likely depends on these relationships for its success, so it is important to make sure that the relationships are stable and positive.

Purchasers are encouraged to evaluate the other party involved in the contract, the contract's historical transactions and the integrity of the products or services provided, if any. Be cautious where the majority of the revenue is from one or two major customers, the loss of which would cause the business to fail.

 3. Look for unfunded liabilities.

 As you analyze the business you hope to purchase, keep an eye out for any unfunded liabilities that could cause financial problems in the future. Common examples of unfunded liabilities include 401(k) plans and pension plans for employees.

If you discover unfunded liabilities, keep in mind that you may be assuming these liabilities when you buy the company. Prior to completing the transaction, make sure that you have formulated a plan for dealing with the unfunded liability after the purchase is complete.

 4. Consider the tax implications of the purchase.

 Depending on the specifics of the purchase, the tax implications for the buyer will vary. When buying a business, the purchase typically falls under one of two categories: corporate stock purchase or asset purchase. In a stock purchase, the individual assets purchased retain their original basis and holding periods for tax purposes and you are assuming all past liabilities of the company.

In an asset purchase, the assets obtained assume new holding periods and basis equal to their fair market values and you are not exposing yourself to any liabilities of the former company. In general, stock sales tend to favor the seller for tax purposes, while asset sales favor the buyer. However, in some cases, a buyer's existing tax situation may make a stock purchase equally favorable.

5. Examine the customer list, bank statements and any other documentation available. 

The final step in the due diligence process is to examine any other documentation available that has not already been analyzed. Because of the size of the transaction, you want to know that you have exhausted every source of information available to you.

Be sure to verify the validity and accuracy of everything represented to you by the seller. If you have questions or concerns, continue to investigate until you have obtained enough information to make the right decision. 

When it comes to business purchases, the complexity of the transaction can vary considerably. Depending on the buyer's level of sophistication, the size of the deal and the buyer's level of confidence in the information provided, it may be wise to hire accountants or other third-party financial advisers to assist with the financial portion of due diligence.

Although this may add to the expense associated with the transaction, the peace of mind you will gain with a thorough evaluation of the target company's finances will be well worth the extra cost.

share this post
Search for matches...
Julie Farless

Julie Farless

Martinez & Shanken, PLLC is a Certified Public Accountant (CPA) firm based in Gilbert, Arizona. We provide a full range of accounting, bookkeeping, consulting, outsourcing and business services, but we specialize in tax preparation. We work with you to ensure that your personal or business processes are conducted in a manner that ensures ongoing integrity in your financial transactions. We are available to answer your questions and help with your ongoing tax planning and changing business needs.

Deborah Martinez & Earl Shanken
29 reviews

Arizona

Recommended Professionals

In the face of economic uncertainty, TaxBuzz is the industry's most up-to-date tax information.

Join 60,000 who get our weekly newsletter. No spam.

We know tax and accounting issues are complicated.

Do you have additional questions on this topic for this author?

Related Posts

Latest Posts