Buying a business is a significant decision. While it can offer exciting opportunities, it also comes with risks. One critical step that cannot be overlooked is conducting thorough due diligence.
This process ensures you make an informed decision, avoid unpleasant surprises, and fully understand the business you're looking to buy. Below, we’ll explore why due diligence is essential and what it typically involves along with some frequently asked questions.
What is due diligence?
Due diligence is the process of thoroughly investigating a business before you go ahead with buying or investing in it. Its purpose is to validate information you have been provided with, identify risks, provide a greater understanding of the business and help to determine value.
Why is due diligence important?
Buying a business is, more often than not, a large investment involving a substantial commitment of time and money, so it’s important to avoid costly mistakes. Due diligence will help you to:
- Validate key information provided by the seller – giving you confidence that the business you’re buying is what it appears to be
- Assess the value of the business – by providing insight into various aspects of the business, such as its financial performance and operations, due diligence will help you to determine its value and make sure you’re paying a fair price
- Uncover any hidden liabilities or risks – liabilities such as unresolved legal disputes or non-compliance with regulations may affect the business’s value
- Negotiate price or terms – due diligence can give you a stronger position to negotiate better terms. Based on what you find, you may want to renegotiate purchase price or other terms of the deal
- Identify future issues and opportunities – it will allow you to spot any potential issues that may arise after the purchase, as well as opportunities for future growth or improvement
- Make a sound decision – ultimately, due diligence helps you to confirm whether you should proceed with buying a business, renegotiate the terms of the deal, or walk away from it entirely
How long will the due diligence process take?
Every deal is different, and the level of due diligence you’ll need to conduct will vary subject to the size and complexity of the transaction. It could take anything from a few weeks to a few months.
Using experienced professionals to undertake the due diligence process is advised and the fees you’ll pay are likely to be minimal compared to the overall size of the investment and the potential losses you could incur from missing something important.
When should I start conducting due diligence?
It's a good idea to engage with professional advisers early on in the process, as they can provide valuable support and guidance when formulating an offer and throughout the due diligence process. How you intend to fund the purchase may dictate what due diligence is required and at what stage. Many funders will require due diligence and their requirements will depend on the nature of the transaction. Due diligence often continues throughout the deal process; the earlier you uncover any potential issues the better.
Types of due diligence
As we’ve mentioned, every business acquisition is different, and the scope of due diligence will vary. One business may need to perform more types of due diligence than another or look at certain areas in more depth than others. For example, for a manufacturing business may need to perform more intensive operational due diligence, while for a technology company you may need to do a deeper dive into intellectual property.
Here are some of the main types of due diligence that prospective buyers will often undertake.
Financial due diligence
Financial due diligence helps to give you an understanding of the company’s financial situation, validate the accuracy of the numbers, and assess the growth potential of the business. It typically involves examining all aspects of the company’s finances, including analysing historical financial statements, tax returns, cash flow records and sales figures, assets and liabilities, financial projections along with systems and processes.
Legal due diligence
This can examine the corporate structure and incorporation documents, reviewing of contracts with suppliers, customers, and employees, checking intellectual property rights, and investigating past or pending litigation.
Operational due diligence
This typically focuses on operational capabilities, processes, and systems. This may include looking at its supply chain and logistics, technology infrastructure, human resources, business equipment and facilities, and supplier and customer relationships. Operational due diligence will help you to identify any operational challenges or risks and potential opportunities for improvement.
Management due diligence
When you’re buying a business, it’s important to make sure you have all the relevant skills to replace outgoing management. Carrying out management due diligence will help you to understand the following:
- Who holds the relationships with customers and suppliers?
- Are the new management team capable of delivering the plan?
- Do they have the skills and experience to enable the business to maintain and grow performance?
- Will there be any gaps in the management team when the vendors leave?
- Where are their weaknesses and what support could mitigate these – could a Non-Executive Director fill any gaps?
To find out more about buying or selling a business and how we can help, visit our buying a business page or get in touch with us.
