There’s an underlying fantasy in almost everyone to, one day, own their own business … be their own boss! Some will go the start-up route and build their dream from scratch, while others will acquire an existing business. There are many steps involved in acquiring an existing business, and one of the key steps is conducting a thorough financial due diligence.  If not done right, it could have dire financial consequences for the buyer. If a due diligence is done right, it could result in identification of new opportunities, minimizing the risks, implementation of cost saving synergies, and peace of mind knowing that the business is compliant, which can lead to increased profitability.

 

Here are some questions a buyer should consider before evaluating a business opportunity:

  • Is the business you are acquiring a right fit for you? Does it align with your long terms objectives and goals?
  • Are you equipped with the right skill-set that is acquired to operate this business?
  • Do you have the right human capital that is necessary to run the potential venture successfully?
  • Do you understand the industry that this business operates in?
  • Do you have the funds available (your own or financing) that are needed to acquire the business?
  • What is the state of industry in which business is operating? Is the industry in the growth stage, mature stage or a declining stage?
  • What is the target market? How has the target market evolved in the last decade?
  • Is the business customer base large and diverse? Or, are the sales concentrated within a few large customers?
  • How many competitors does the business have? How is the competition doing?
  • What are the economics of the region that the business operates in? Is the region’s population and economic growth above average?
  • What is the employee profile of the business? Are the employees required to have specialized or generic skills? How long have the employees been with the business?

 

Once you have answered these critical questions, the next step is to look for a business that meets your criteria. This is where you can work with a qualified business broker, such as AR Business Brokers. After finding the business that you are looking to acquire, the next step is to prepare the offer to purchase the business. It is imperative for the buyer to have exit clauses in the offer in the event that the buyer decides to walk away from the deal.

In the offer, a critical clause is the performance of a financial due diligence to ensure that the business’ financial performance is aligned with the listing that seller has advertised. Financial due diligence is the process of reviewing the financial information available for the business. The objective of financial due diligence is to assess the accuracy of the financial information presented, as well as perform high-level financial analysis on the business, so that there are no unpleasant surprises after the business purchase. Financial due diligence simply means digging deeper through the financial records to get comfort before making such an important decision.

Due Diligence should cover the following areas to ensure there are not potential alarming issues that can hamper the business in near future:

Financial: Ask for the company’s audited or unaudited financial statements. Request balance sheets, income statements, and cash flow statements, as well as business tax returns for the past three to five years. You and your accountant should review them with the following in mind:

  • Is the business collecting its accounts receivable in a timely manner?
  • How much bad debt does the business write off each year?
  • Is the business paying its debts in a timely manner?
  • What is the business’s profit margin?
  • Does the company have any outstanding liens?
  • Is the business up-to-date with Canada Revenue Agency (CRA) filings?
  • Are there any amounts owing to CRA?

Legal: Ask for copies of the business’s professional and consulting agreements; insurance policies; licenses and permits; any documents related to intellectual property, such as patents or trademarks; and any documents related to lawsuits the company is involved in. You and your attorney should review them with the following in mind:

  • Are the agreements enforceable?
  • Does the company have the rights to its intellectual property?
  • Is the business adequately insured?
  • Are the company’s licenses and permits current?
  • Is the company involved in any litigation, and if so, what are the potential risks, costs, and damages?

Employees: Request organizational charts, employee handbooks, employment agreements, wage and salary information, benefits plan, non-compete agreements, and confidentiality agreements. Review them with your attorney, keeping in mind:

  • Do any employee policies put the business at risk of lawsuits?
  • Are there any ongoing grievances with employees?
  • Are employees attempting to unionize, or is a third party trying to unionize them?

Business structure: If the business is a corporation, ask for a copy of its corporate charter and bylaws as well as all minutes of meetings held with the board of directors and/or shareholders. Have your attorney review this with you, considering:

  • Is the business in compliance?
  • Is the business structured properly for your growth plans, or will you need to change its structure?
  • Will you need to buy out shareholders, and if so, what will that cost?

Operations: Ask for a list of customers, lists of suppliers and vendors, and an operation manual. Review this information while considering:

  • Does the business have adequate inventory systems in place?
  • Is the company’s supply chain diversified so that the business isn’t overly reliant on one supplier?
  • Is the company’s customer base diversified and growing?
  • Does the company have necessary equipment and infrastructure in place for continued growth?

 

At the end of the financial due diligence process, you should have a clear picture of where the business is today, where you can take it in the future, why the owner is selling, and whether the asking price is fair.

 

Please contact our team at Think Accounting & Consulting and we will be glad to assist you with your financial due diligence needs. We will work with you as a team to guide you through the process of acquiring your next business.