Due Diligence Check Lists

by Peter Siegel, MBA and founder of BizBen

Due diligence checklists are needed by entrepreneurs buying a business so he or she can conduct a careful analysis of any company that seems a good purchase candidate. These checklists also helps the seller know what information to provide.

On the due diligence checklist for proactive business buyers there are:

1. Profit and loss statements and balance sheets describing the company's financial performance represent one of the first things to look at. Older guidelines suggested the buyer get at least a three-year history of income and expenses to determine the degree of profitability, and the list of assets and liabilities to see what changes have been made over the period being reviewed. Because of the recent dips in the economy, it now is recommended that the buyer review five to seven years' of history to gain an idea of the overall financial pattern for the business.

2. Supporting financial documentation to review includes accounts receivables and accounts payables legers, depreciation schedules and related reports. If the buyer requests and seller agrees to a more thorough analysis, the due diligence may include a review of bank records, tax returns, vendor invoices, along with sales and payroll tax filings. Supporting documentation might also include equipment maintenance records and employee files.

3. Premises leases and equipment lease agreements should be reviewed so the buyer understands the lessee responsibilities under those agreements.

4. Additional investigation includes a call to the better business bureau to learn about the company's reputation in the community, and an analysis of account concentration to verify that the business is not relying on just a few customers. Conversations with key employees, major vendors and any landlords will help reveal whether the business has a record of honest dealing and prompt payment of obligations.

5. Are the business permits and licenses valid and up to date? Checking with the issuing agency might be a good idea if there is any question about the authenticity of the documents shown.

6. The list of all assets to be sold to the buyer should be reviewed. It will be referenced shortly before close of escrow. That's when the purchaser should investigate all of the equipment, machinery and other property of the business, to make sure it is in working order, and, if needed, properly registered and inspected.

7. Some detective work on the part of the buyer also is recommended. In the case of a retail business, for example, it's important to "case" the neighborhood to learn how many similar companies are located close enough to the business to be competitors. There usually is no single rule regarding how much competition is too much, so the buyer will need to make a subjective judgment about the possible threat posed by other nearby businesses. The point is to make sure and conduct this part of the due diligence study.

The detective work might include visiting the city's planning department to learn if any dramatic changes are scheduled for the area. More than one buyer has wished he would have done this before buying an enterprise that went out of business shortly afterward, because a large competitor moved into the neighborhood. Or because road or building construction disrupted the auto or foot traffic on which the businesses depended.

8. Industry specific investigation also is recommended. Are new environmental regulations about to make the company's equipment obsolete? Also a problem is out-of-date vending machines that put the business owner at a disadvantage when competing with other businesses using newer vending technology.

Industry specific knowledge also is useful when determining if cost of goods and other business expenses are in line with those of other companies in the business.

9. Right before close of escrow an inventory of all products for resale, as well as parts and supplies should be conducted to make sure the value equals the amount being paid for these assets.

10. Also of concern is that the seller holds clear title to any and all assets of the business being sold, unless disclosed otherwise. The buyer wants no surprises. Since title searches are ordinarily the job of the escrow officer, this aspect of due diligence will likely be covered. But it's a good idea to make sure the escrow holder is experienced at handling business transfers and knows how to do this properly.

Due diligence is a critical step in buying a business and it's important that the process is conducted as thoroughly as possible.

Contributor:  Joe Ranieri - Orange County

For liquor stores and other retail locations, I advise the buyer to call the local police department and speak with the watch commander to see what type of crime there is in the area, and if that particular location has ever been held up. If the location has been held up numerous locations, the buyer may want to see if the seller is willing to pay for bullet proof glass at the register. No business is worth dying for, no matter what the gross sales are, but a smart owner can protect themselves with bright lights, working cameras, and other precautions.