Small business due diligence is a sort of investigation done by a professional on behalf of potential business owners before they sign a contract that will subsequently lead to change in ownership but after the buyer and seller has already agreed on terms of the dealing.
When it comes to due diligence, it is by law the responsibility of the prospective buyer to know the ins and outs of the business they are buying. And this is where the problem lies as not all aspiring small business owners have the technical know-how as far as business due diligence is concerned.
There is no iron clad way of doing a business due diligence but whatever approach you decide to follow, make sure you get as much facts as you possibly can during this process because that is the essence of the whole process.
This article is a simple guide that is specifically designed for appraising small business purchase; this does not in any way imply that the tips discussed here cannot be applied when making decision in buying larger business entities.
Preliminary Steps in Small Business Due Diligence
This section of this post briefly outlined the preliminary steps that have to be taken before going into the proper business analysis.
Identify a target
Investors buy promising start-up businesses for various reasons. One of such reason could be the fact that the investor does not want to get his or her hands dirty with the nitty-gritty of starting and grooming a small business. Whatever the reason might be, it is vital that you find a small business that will fit into your investment philosophy. Alternatively, you can use yellow book to find these kind of business.
One of the tools use to find promising small business for my clients is the google alert, simply subscribe to receive alerts of the activities of small businesses that are in the niche you are looking at.
Approach owner to make sure they want to sell
In as much it is difficult to identify a target business to buy, it is even more difficult to convince the owner to sell. People start-up businesses for various reasons and if one of the reasons is not to grow and then sell the business, it will take something really special to make the owner sell.
From experience, most owners that are eager to sell to any prospective buyers are doing so because they could see danger ahead or that they underestimate the true value of their business.
Request detailed information
Assuming the owner of the business is interested in selling, an initial intent to sell documents is signed. At this point then it is imperative that all relevant information pack is collected. The potential seller will at this point be careful not to give out sensitive information; this is fine, deal with whatever level of information you are given.
Value the business
Applying any business valuation method of your choice, carryout out an initial valuation of the business just to get an idea of what the big picture will look like. A lot of business valuation professionals will question the rationale behind this point, but, think of it as an initial conviction that you will not be wasting your resources evaluating the business.
DUE DILIGENCE CHECKLIST
The rest of this article on small business due diligence will be devoted to highlighting those aspects of target company has to be thoroughly analysed.
You understand the business environment by performing some fundamental analysis on the potential business that you are planning to buy. Below are issues that need to be addressed by whoever is doing the due diligence.
- Market, is it volatile or stable?
- Is there a close substitute for the
- Position of the company, use Porters five forces and other tools
- Mindset of employees, any key staff lost recently?
- Control environment
- Political and legislative impact on the business
- Social reputation of the business, analyse any negative press at the very least
No business diligence is complete with considering financials. Below are areas where facts must be gathered.
- Sales growth
- Accounting system
- Credit status of the owners
- Asset base and its quality, including any intellectual property
Legal issues (resolved and pending)
- Implication of already decided cases
- Implication of any potential liability
- Establish current ownership structure
- Business contracts
- Licensing and franchising
Current innovation system
- Technology platform
- Research and development
- Who associates with the current owners- due they have any criminal records?
- Professional and business association that the owners belong to
- Legal advisers
- Financial advisers
- Auditors of the financial statement of the enterprise
- Business risk
- Financial risk
- Legal risks
- Reputation risk
- Operational risk
Potential of the business
- Demography of the users of the products
- What kind of products- is it an ever green message?
- Product life cycle stage
- Sales and distribution channel
Small business due diligence is like a feasibility study but on a larger scale. It is the responsibility of the potential buyer to know the business and this can be done by professional accountants especially those that are especially accountants that have experience of business turnaround as they can easily recognise problem area when they see one.