You wouldn't expect to buy a car without first checking it out, would you? You would need to know if the transmission made any whiny noises, the gears crunched when they were engaged or if it over-heated badly when stopped in traffic. We classify the purchase of a vehicle as a "big ticket" purchase and something that needs extra thought and attention, before we move forward. Shouldn't you also "look underneath the hood" if you were considering buying a business from somebody else, as well? It's very important to create a due diligence checklist, revealing any hype created by the seller, to ensure that only the hard facts and figures are available to be either corroborated, or overturned.
We drew an analogy with a car purchase. The car is, of course, a mechanical object. When assessing the value of the car, what you see is what you get to a certain extent and any otherwise "hidden" elements can be revealed, with the assistance of a qualified auto shop mechanic if needed. Conversely, the purchase of a business is rather dynamic and is often very difficult to qualify or quantify. Consider how much "goodwill" is often factored into the value of the business and how the seller's reputation, developed over time, is quite important. The owner may often establish a number of claims that are subjective and as business valuation is so difficult, the establishment of a due diligence checklist is even more important.
You will often be required to put some kind of financial consideration into escrow before you will be able to gain access to some of the more confidential facts and figures associated with the business for sale. Whenever you are requested to do so, always ensure that you have an accompanying agreement, couched in language to protect you. You should specifically note, that if you find information that causes you to change your mind, you will have the right to the refund of the deposit. Normally such clauses are accompanied by a specific time frame, during which time you will have the opportunity to inspect the assets and records.
People often assume that the most important records are the financial statements. While these documents are, of course, fundamental to the viability of the operation, you need to immerse yourself completely in the business in question and look laterally at the industry around you. You will, of course, not have access to your competitors’ facts and figures to any large extent, but you can still look at how they operate the business and can make certain, educated assumptions by reading between the lines. Look at the contracts in force with prime vendors and other contractors, essential to the operation of the business. In particular you should see whether these agreements are well written, are portable, could be improved in any way and most certainly make sure that they do not contain any potential stumbling blocks ahead.
As you process your due diligence checklist, you should be able to gauge how the outgoing seller has marketed the business and take a view of how effective such marketing has been. This will give you an idea of the potential, or lack thereof, should you decide to take the reins!
Richard Parker is the author of the How to Buy a Good Business at a Great Price series. As President and founder of Diomo Corporation - The Business Buyer Resource Center, his materials, seminars and consulting have helped thousands of business buyers realize their dream to buy a business.