Understanding Due Diligence When Buying a Business

February 2019 | Article

Are you looking to expand your business? Broaden your geographical presence? Diversify your service offerings? The process of acquiring another business can be time consuming and intense, but it’s a necessary step to grow your organization. One of the first things to consider as you work through the merger and acquisition process is the necessity of buy-side due diligence.

What is buy-side due diligence?
In a nutshell, buy-side due diligence allows you to make an informed decision on the potential acquisition and terms you feel comfortable with. The due diligence process ensures all information associated with the deal (financial, operational, tax, IT, HR, etc.) is considered and up-to-date, so you know exactly what you’re buying

What does the process look like for due diligence when buying a business?
Once you’ve identified a potential acquisition or Target, the next step is to review their information and request any additional items you may need. Most often, your lender (or another party) will request a third party perform financial due diligence, known as quality of earnings.

The next step is to inquire with various third-party vendors about whether they can perform due diligence. Most often, these are CPA or business advisory firms. Ensure you look for vendors who specialize in due diligence and have a proven process to help you address key aspects of the deal as well as major concerns.

Together with the vendor you have chosen, you will need to decide the scope of work. Each deal is unique and has multiple facets to consider. A typical buy-side due diligence will include the following:

  • A quality of earnings report
  • Revenue and margin concentrations
  • Add-backs and EBITDA adjustments proposed by seller
  • Review of significant estimates
  • Normalized working capital
  • Tax matters, including state and local tax reporting
  • Cyber security considerations
  • Technology limitations
  • Other diligence including legal, environmental, human resources, insurance, etc.

After the scope of work has been decided, an introduction will be made to the Target’s CFO/sell-side advisor. Together, these advisors will facilitate the due diligence steps for both buyer and seller. At this stage, you will also need to send along the advisor’s data request list and set expectations for the timeline going forward.

From here, the process will flow through the buy-side and sell-side advisors chosen by each respective party. You, as the buyer, can be as involved as you wish in the due diligence process. It’s recommended you be an active participant and take part in calls and visits, so you can ensure you’re getting the information you need to make an informed decision about your potential acquisition.

Normally, the financial and tax due diligence process takes three to five weeks for a report to be presented in draft form. At this time, you will have a follow-up call with your advisor to discuss the findings of the report. These findings could impact the deal terms, historical performance or prospective earnings, so it’s important to make sure you have detailed conversations with your advisor to address concerns and questions.

Step-by-step guide for buy-side due diligence

What other items could be included in buy-side due diligence?
In addition to the items listed above, a buy-side due diligence agreement could include:

  • A financial analysis to better understand daily operational and financial questions.
  • A forensic examination and/or background checks. This will allow you to uncover the risks associated with your potential acquisition.
  • An analysis of the tax ramifications of the sale.

What do I do next?
Before buying a business, it’s important to make the sure the math adds up. Buy-side due diligence allows you to make an informed decision before you sign on the dotted line. When you work alongside a team of advisors, you will better understand the ins and outs of your potential acquisition as well as the impact it will have on the company you’ve worked so hard to grow.

Need more resources?

  • Check out our step by step infographic on how to get started.
  • Want to learn more about essential steps in the due diligence process? Check out this article on essential steps for both buyers and sellers.
  • Want to learn more about how to go about quality of earnings and its impact on selling a business? Click here.

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