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Due Diligence


Due Diligence - Investigating a Business

Question:
I am in the final stages of an offer on a business. The due diligence will start afterwards but the seller is insisting on a five-day due diligence period. Is this reasonable? Also, what do I need to prepare? And, what should I really check out? I want to buy the business, but what can I tell the seller to negotiate a longer period? I'm sure I need at least three weeks.

Answer:
I could probably devote ten pages to answering this question because this is such an important stage in the business buying process. However, I shall be brief. First, five days is ridiculous. How can you possibly learn what you need to know about any business in such a short time? Now, don't get me wrong, the actual financial review can almost always be completed by a competent accountant in a couple of days as long as the seller provides you with complete information.

From a buyer's perspective, however, there is far more to check out than just the financials. This includes the assets, legal issues, contracts, suppliers, employees, marketing/sales plan, the industry, the competition, etc. Interestingly enough, there are over 200 individual points to review in any thorough due diligence.

Regarding the seller, you should be upfront with them and tell them that you are sincerely interested in buying this business, and you want to get it to the closing table. But, there is a lot to review and you certainly don't want to rescind your offer simply because of a time factor. Further, you will be investing a lot of money for an accountant and this alone should demonstrate that your serious. Unless the seller has all kinds of hiddent problems, they should not fear a two- to three-week due diligence at the very least.

It's funny because in my career I have sold nine businesses that I owned. In each transaction, I let the buyer take as much time as they needed because once I found the right buyer, and had a satisfactory deal in place, I wanted to make certain that the deal closed. By the way, 8 of the 10 closed with those buyers. Any reasonable seller will agree with this philosophy and, if they don't, you may want to reconsider the situation entirely.

Conversely, if you've already done your research on the business and all of the other components noted above and this is simply a financial review, then chances are, you can get everything done within a five-day period.

On a separate note, if you'd like to learn about due diligence, you can download a 200-point due diligence guide here

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Due Diligence: When to walk away from the deal

Question:
We are currently in due diligence on a wholesale/distribution company and we are finding the operations do not seem to run as smoothly as the seller has indicated. My future partner feels we should try to get a price reduction. I think we should walk away from the deal altogether. Do you have any thoughts on how to handle this situation?

Answer:
Most businesses don't operate as well as the seller represents - remember, they're trying to sell you their business! That being said, I don't agree with you to simply walk away because that will likely lead you on an endless search for the perfect business, which doesn't exist.

In nearly every due diligence, you are going to uncover some inconsistencies. The issue is to separate them into incidents and/or catastrophes. You should overlook the incidents and deal with the catastrophes. This could mean renegotiation or it could require you to walk away from the deal.

In this case, it doesn't sound like a catastrophe at all. However, you need to determine what it will take for you as the new owner to get the business running like you want it to and at what cost. This is part of the process of buying and operating the business.

My bigger concern here is the fundamental difference you and your partner have in evaluating this business. It sounds to me like you have very different criteria about what you each want in a business. You both need to have the same philosophy in evaluating businesses even if you have different strengths. This does not mean you must always agree with each other. Constructive debates are a good thing, both now and when you are co-owners. However, the overall vision of what you want in a business, what constitutes a good business, what each of you are looking for, and how you will agree to deal with challenges and set-backs during this process and after you are owners, should be issues that you deal with together right now.

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Due Diligence of Online Businesses

Question:
Hello Richard. I purchased your course last December and it's been very helpful. In my area (Seattle) the business listings have been terrible for the last six months. To combat that, I've decided to expand my search to relocatable online businesses. My question, how do you perform a proper due diligence with something that's as intangible as online businesses?

Answer:
Great question, and you'll be pleased to learn that performing the due diligence for an online business is basically the same as a bricks-and-mortar one, at least from a financial perspective. The numbers are the numbers. The critical components are in the actual operations of the business investigation: to be certain that any software being used is licensed; if it's an e-commerce-enabled business, that you'll be able to secure the same terms from credit card processors; that they have proper ownership of the domain and that you can readily operate the technical side of the business (Website maintenance, changes, etc). Also, depending on the nature of the business, is there a programming element that the seller has that you may not be able to work with? Who handles the Website? What does the owner do everyday?

The other thing to be careful about is the non-compete. If it's a business with a low barrier to entry, then you will need a mechanism to be sure that the seller does not compete with you. The problem is that an online business can operate discreetly from anywhere and the last thing you want is to chase the former seller for having allegedly breached the agreement.

On the other hand, online businesses can be phenomenal. The best thing we ever did was to convert our business into an online venture. It's the ideal business model: high margins, no inventory, no receivables, few employees and, best of all: the world is your market.

If you'd like to speak me with directly, because you are a Diomo client, please email me at the address in your original order receipt or through the contact page on our Website and we can set up a phone call together.

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Fees Involved With Due Diligence

Question:
I am seeking to be a 'first time' buyer of a business. I understand that I need due diligence, and that I need expert help, but what should I expect to pay for this service? How do they arrive at a fair figure to charge?

Answer:
For the financial due diligence of a business you will need to engage an accountant to complete the review. Before we discuss approximate costs, there are several important factors to consider which will have a direct impact on the final costs incurred for their services :

  • Hire an accountant who has experience in completing the due diligence review of similar businesses.
  • Use an accountant that makes sense – you don’t need a Big Three CPA to review a small business.
  • Lay out very clearly what it is that you want them to do, along with what they recommend is required.
  • Have them provide you with an estimated cost to complete their work.
  • Don’t start the review until you have all (or the vast majority) of documents and files required for them to complete their work.
  • Get a listing to the sellers as soon as possible after you have a signed agreement in place.
  • As a last point, consider the timing of the due diligence schedule. If it’s going to be near the end of a calendar quarter or tax season, you’ll want to give them plenty of notice before.

On the first day of the due diligence period, review all of the documents that the seller has provided. Chances are if it doesn’t make sense to you, it won’t to your accountant. Plus, if a lot of material is missing, you won’t be paying the CPA to sit around and do nothing.

Insofar as costs are concerned, I have found that most small businesses being sold for under $500,000 will cost around $2500-$5000 to complete a detailed financial review. Conversely, I have paid as little as $1500 to have a very competent accountant do the work, but I made certain that it was flawlessly organized for them beforehand.

Most accountants, unlike attorneys, will provide you with a very accurate quote of what they feel the final bill will be. The difference between the two professions is that the financial review steps are fairly standard and so they can closely predict the time that may be involved.

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By: Richard Parker: President of The Business Buyer Resource Center and author of How To Buy A Good Business At A Great Price©

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