How is the Due Diligence Process when purchasing a Business in the USA?

You are interested in purchasing an existing business (excluding franchises) and want to put an offer.  Once it’s accepted, what should you do next?

 The first step is to hire all necessary professionals who will be involved in the Due Diligence process.   We highly recommend our Buyers to not do the diligence themselves, but to count on neutral and experienced professionals to assist them before a final decision is made. We also recommend that these professionals be chosen before you submit an offer to avoid delays. For ethical reasons and to avoid any conflict of interest issues, your business broker should not be involved in the due diligence process, other than assisting and guiding you through the steps and coordinating actions if necessary.   

 Please remember that business brokers are not responsible for the information received on the business, neither can then influence you on your decision. 

Which professionals should I hire?

 It all depends on the type of business, its complexity and particularities.  For example, for small businesses, service providers and companies with simple operations, we recommend Buyer to hire at least an accountant to verify the financial information provided by the Seller.   For businesses that are sold with real estate, machinery and equipment, we also recommend an inspection by a professional in the area.  The idea is to check everything that may affect the business after the closing. The list of possible professionals to be hired does not stop here.  For any point of uncertainty or doubt by the Buyer, he should look for an expert’s opinion. 

 Another important thing to consider when hiring an accountant for the diligence is to look for professionals that are experienced in business due diligences.  The reason is due to the fact that most small businesses do not report 100% of their gross and  net income and the experienced accountant will know which other methods he can use to verify the accuracy of the information provided by the seller.  And accountants should not tell you how much a business is worth, as this is a business brokers/intermediate’s job to perform.  Your business broker should have the training, experience and ability to evaluate the worthiness of the business you are buying based on the verified information.

 In all business sales/purchase transactions, there should be a corporate attorney hired by the parties to check all legalities of the business, whether there is any liens or issues that may prevent the transaction to be concluded, besides preparing all closing documents and registering the sales with the appropriate legal entities.  These attorneys do not represent any of the parties, are a neutral point in charge of the legal aspects of the transaction and the closing documents (like a “title company”).   Therefore, you may want to consider hiring an attorney to exclusively represent you and review the offer, closing documents, provide guidance, make recommendations etc. Most sales of small business transactions, though, do not include a separate attorney because of the costs involved.

Which documents and information are used during a due diligence of small businesses? 

 Among the most common requested documents by the accountants are:  Profit & Loss Reports, Balance Sheets, Tax Returns, POS reports, bank statements, sales tax and payroll reports.  As far as the period, it is usually from the last 2-3 years + year-to-date. This list may vary according to the accountant’s analysis.

 Another diligence/analysis that we recommend our Buyers to make during this period is to read and assess the rental agreement of the business premises (if applied), in case the real estate is not included in the sale (most of the cases).  In this instance, the Buyer should evaluate whether the current lease/rental conditions are transferrable to the new owner, whether there will be a need to negotiate a new one, when the current agreement expires or is extended to, and any other information that may impact the business after the closing. Also very important to check is what modifications (if any) the new business owner will be able to make (whether material, services or products sold), according to the bylaws, rules etc.

Can I trust 100% in what the business is reporting and what the accountant was able to verify? 

 The Due Diligence process will serve to confirm the information provided by the Seller and reported on financial statements, tax returns and other possible sources (like a POS for example). .There is no way, though, an accountant can guarantee that the numbers reflect 100% of the business’ reality, unless there is a formal audit, where every line of the financial statements are audited at its source (vendors, customers etc), which can be very costly and time consuming.   Audits are for large corporations and partnerships with many partners. Audits for a small business would cost at least $10,000 and takes 2-3 months, and most small businesses do not have the money to do this. A due diligence process is a modified version of an audit in which the information on tax returns and financial statements are reviewed and supporting documentation is requested.  We recommend that you know upfront how the accountant works, what is expected as far as the results, what exactly he will check; if you want him to do other things or have different expectations, make sure to negotiate it and have it all clarified before he starts the job.

What is the average cost of a due diligence for small businesses (being sold up to $500k)? 

 It will depend of the complexity of the business, the documents made available by the Seller and the time it will take for the accountant to gather and go through all of them.  The cost may be as low as $2,000 and exceed $20,000 in the worst cases. This is why the role played by the involved business brokers is key to the efficiency and speed of this process.    For instance, Florida 360’s business brokers do not accept a listing if Seller is not able to provide all or the majority of the crucial documents required for the diligence.  And when we are representing a buyer, we will not submit an offer before the selling agent confirms which documents will be available for the diligence. 

 We hope this article will of help to you. We can also provide you with a step-by-step process in your sales or purchase of a business!

 Contact us at your earliest convenience.  We have over a decade of experience in assisting business buyers and sellers  in South and Central Florida