The Importance of Due Diligence to Businesses and Investors

Buying a business that’s already in operation poses a smaller risk than getting a completely new one off the ground. Typically, with a business that’s already in operation, the founders have already solved the key start-up issues. Licenses have been obtained, relationships with supplies have been established, an accounting system is in place, customers are already walking through the door, and employees have been hired.

In a nutshell, with an established company, the business model, strategy, effectiveness of marketing, and advertising have been proven to effective. The acquisition process however comes with challenges, both for the buyer and seller.

How Due Diligence Can Benefit Businesses and Investors

Assessing Risk and Opportunity

As a buyer, you’ll likely fret about many things. Does the financial information accurately reflect the business’s condition? Are their hidden or undisclosed liabilities and issues that may devastate the business in the future? Will the business’s performance match what the sellers have projected? Will the business’s cash flow be enough to shore it up? All these questions addressing risk can only be answered through a due diligence process.

What if there is a likelihood that the business could sign a lucrative deal in the future? What if there is a future event that could help the business soar? Risk and opportunities and are like Siamese twins. Due diligence not only reveals risks that may threaten the business’s sustainability in the future, but it also shows an investor opportunities that may improve the fortunes of the business.

Due Diligence as a Tool for Internal Evaluation

The business owner is the biggest investor in the business in terms of commitment of time, reputation, and capital. So if it makes sense for buyers to conduct due diligence to assess the accuracy of the information provided, then business owners too can use due diligence to find out how they can improve the valuation of their businesses.

Despite business owners being deeply involved in running their businesses, they rarely have all the information about the businesses. An internal assessment before selling the business will help the owner identify areas of the business that need improvement before they get into any sale negotiations.

For instance, an assessment of the sales infrastructure may reveal that there are simple and affordable changes that can be made to improve the sales process and consequently the sales projections. A business owner can greatly improve their negotiating power if they make these changes before meeting the buyer.

The Sell Price Conundrum

Sellers tend to overvalue their business due to emotional and personal attachment. Conversely, buyers tend to undervalue a target business due to the financing or cash available for the acquisition. To get to an objective valuation, they both need to conduct due diligence to assess all the aspects of the business.

Conducting Due Diligence

Buyers conduct due diligence to ascertain the veracity of the information that’s been provided by the sellers as well as to understand all the various aspects of the business that’s on sale.

An effective due diligence process entails careful planning, retaining reputable auditing services providers as well as skillful execution. A minimum, due diligence should cover the following areas:

• The business’s background and history
• Financial performance – the effectiveness of the business’s operations as well as the quality of its earnings
• Employee commitment as well as their strengths and weaknesses
• The Strength of the Business’s financial position
• Assessment of the current and future cash flow
• Close off review
• Evaluation of tax due

Other areas, that are viewed as optional but are vital include:

• Acquisition accounting
• Review of foreign currency exposure,
• Review of related party transaction
• IT Environment review
• Review of lease agreements

Due diligence, as you can see, it gives you a comprehensive as well as an in-depth look at the business on sale. You get to see the business from a wide-angle, starting from its past to its future. This information bolsters your ability to negotiate a fair deal.

Common Due Diligence Mistakes

Here are common pitfalls that you should aware of as you plan for the due diligence process.

• Not working with experts
• Not conducting a comprehensive due diligence process
• Not demanding for full disclosure of information as part of the sale/purchase process
• Not assessing the short-term financial outlook
• Relying on unaudited information

Also, due diligence is an opportunity for the buyer to determine whether the target business fits into their current operations. For you to figure this out, you should ask these essential questions:

• Do your values align?
• Do your cultures align?
• Can the effectiveness of the business operations be improved by integrating their products into your existing channels?
• Will key employees remain committed to the business after the sale?
• Will the suppliers stay after the transaction?

In a Nutshell

Due diligence is typically conducted to ascertain the accuracy of the information provided by the seller, but it can help both the buyer and seller determine the true value of the business.

The role of the due diligence analyst includes, verifying the accuracy of the information supplied by the seller, looking for undisclosed issues, and uncovering concealed assets and opportunities.

If due diligence authenticates the seller’s account, a buyer can sign the deal with confidence. Besides, if the auditors stumble on neglected or hidden assets, this will increase the deal’s value. Conversely, if due diligence reveals hidden issues, the buyer can either renegotiate or walk away from the deal. Whichever the case, due diligence will help both the buyer and seller strike a fair deal.